SECURITIES AND EXCHANGE COMMISSION
ADVISORY COMMITTEE ON THE
CAPITAL FORMATION AND REGULATORY PROCESSES
July 24, 1996
Chairman Arthur Levitt
Commissioner Norman S. Johnson
Commissioner Isaac C. Hunt
Securities and Exchange Commission
Washington, DC 20549
Dear Mr. Chairman and Commissioners:
The Commission's Advisory Committee on the Capital Formation
and Regulatory Processes is pleased to transmit its final report
to the Commission. The Committee unanimously recommends that the
Commission act promptly both to strengthen existing investor
safeguards and to reduce the costs of corporate capital formation
in the United States by establishing a company-based registration
system.
Company registration is the logical culmination of a
progression over the past three decades -- a progression
encouraged by Congress, investors, industry and others -- away
from the transaction-based framework for the registration of
securities offerings. On numerous occasions in the past, the
Commission, just as it has done now by creating this Committee,
has recognized the need for reforms in the transaction-based
system. In 1982, for example, the Commission took a major step
towards the goal of company registration by establishing its
precursor -- the integrated disclosure system for the primary
offering and secondary trading markets, and the concurrent
adoption of the streamlined shelf registration procedure.
Consistent with the view of a decade and a half ago, the
Committee today believes that the transactional concepts still
underlying the current scheme continue to impose unnecessary
costs and restrictions on issuer access to capital. Perhaps more
importantly, in many instances the transactional system also
serves as an impediment to full and timely disclosure to
investors and the markets, and the realization of the full
potential for investor protection provided by the Securities Act.
After much research, study and debate, the Committee
has concluded that the significant changes in the securities
markets over the past sixty years, which have accelerated in the
last dozen or so, continue to strain the remnants of the current
transactional registration scheme. More specifically, as
detailed in the Committee's report,
the Committee has identified a variety of regulatory
uncertainties, complexities and anomalies, many of which stem
from efforts to adapt the Securities Act's registration and
prospectus delivery provisions to current market developments.
Over time, the continuation of these changes will reduce the
current scheme s ability to provide the highest level of
essential investor protections.
Moreover, certain innovations brought about by, among other
factors, technology and the globalization of our markets, while
benefiting issuers, have not always produced meaningful
countervailing benefits for investors in either the primary
offering or secondary trading markets. In fact, in certain
cases, these innovations have had the unintended consequence of
possibly weakening available investor protections. In addition,
they have not addressed the concerns of other market participants
who have legal obligations created under a scheme crafted in the
1930s, but whose ability to execute their duties has come under
stress in the financing environment of the 1990s.
Accordingly, the Committee commends Chairman Levitt and the
Commission for charging the Committee with the responsibility to
evaluate the continuing efficacy of the present scheme governing
corporate capital formation, and to consider and, if warranted,
recommend an alternative approach. The Committee recognizes that
streamlining can be accomplished at the expense of, or at least
without increasing, investor protection. Consistent with the
principles of Chairman Levitt s leadership and the Commission s
historical approach, the Committee refused to proceed in that
direction. It assumed the mandate of crafting a system that
would both increase investor protection and reduce regulatory
burdens.
Under the new approach, reporting companies will benefit
from an offering process that essentially converts the current,
stop-and-go shelf registration system into a continuous, pay-as-
you-go registration process. Under a full company registration
system, the one-time registration of eligible companies generally
would encompass all securities that they or their affiliates
might offer or sell thereafter. Issuers and investors will both
benefit from this fundamental conceptual change that will
eliminate artificial distinctions among the markets for the
issuer's securities and the restrictions on the resale of those
securities based upon the nature of the transaction in which the
security was initially sold. In addition, investors benefit from
an appropriately expanded reach of the Securities Act s liability
protections to cover more transactions, including private
placements and the flowback of offshore offerings, and more
disclosures, than under the current system.
Importantly, an integral part of the company registration
system is improvements in disclosure practices by registered
companies. Increased attention focused on the periodic reports
provided to the markets makes sense. Investors rely on those
reports in deciding whether to buy securities pursuant to an
offering by a public company or any of its affiliates. They also
rely on those reports in deciding whether to buy or sell that
company's securities in the secondary trading markets. The
secondary trading markets have grown so substantially, and so
dwarf the primary markets, that a disclosure system that relies
on high quality disclosures only when a company episodically, if
ever, goes to market disserves the investing public. Moreover,
in order for a streamlined offering process that relies on the
existing periodic reports to work without harming investor
interests, the system must ensure the highest level of integrity
for those periodic reports. Any streamlining without improving
the current disclosure process should not be acceptable.
Consequently, the company registration model includes specific
reforms tailored to enhance the accuracy and reliability of
information, and the timeliness of the information, furnished by
registered companies to investors and other participants in the
securities markets.
The company registration model also reinforces investor
protection by incorporating measures that enhance the monitoring
functions of underwriters, outside directors and auditors. All
these reforms are loyal to the central premise that the benefits
and protections of the regulatory process, heretofore triggered
by the infrequent and unpredictable occasion of a public offering
of securities, should operate on a continuous basis for the
benefit of all investors in the company's securities.
The Committee recommends that the Commission pursue as its
ultimate goal the implementation of a full company registration
model that eliminates completely the need to register securities
offerings, thereby replacing the current transactional
registration requirements and exemptions for all reporting
companies. The Committee also recommends, however, that the
system be initiated through a voluntary "pilot" program open only
to larger, more seasoned, companies. The Committee believes that
such a pilot will provide a meaningful market test of the
advantages of this model and will provide greater flexibility for
any experimentation or adjustment the Commission might deem
necessary or appropriate. The pilot program should provide the
foundation for deciding what legislative and regulatory
modifications, if any, would be appropriate to complete the
transition to a company registration system.
In closing, the Committee's members wish to thank Chairman
Levitt and the Commission for the opportunity and the privilege
to serve on the Committee and to participate in these important
reforms. The Committee strongly believes that this new system
will provide companies and their investors with a regulatory
scheme to meet their needs in the new century. At each of the
times in the past when the Commission considered bold action that
would both improve investor protection and streamline the capital
formation process, this country's markets were the largest, the
most liquid, the deepest and the most honest. Each time
regulatory innovations were in fact adopted that combined both
investor protection and streamlining, the markets became even
better. The Commission has the opportunity to do that again
here. Each member of the Committee looks forward to the
Commission's progress in considering the Committee's
recommendations, and remains willing to provide any additional
assistance in this regard.
Respectfully submitted on behalf of the Committee,
The Honorable Steven M.H. Wallman
Committee Chairman
Members of the Committee:
Professor John C. Coffee, Jr.
The Honorable Barber B. Conable, Jr.
Robert K. Elliott
Edward F. Greene
Dr. George N. Hatsopolous
A. Bart Holaday
Paul Kolton
Roland M. Machold
Dr. Burton G. Malkiel
Claudine Malone
Charles Miller
Karen M. O'Brien
Lawrence W. Sonsini
TABLE OF CONTENTS
I. INTRODUCTION AND SUMMARY
A. Findings and Recommendations of the Committee. . . . . . . . . .
B. The Work of the Committee and Structure of the Report. . . . . . .
II. RECOMMENDATIONS OF THE ADVISORY COMMITTEE
A. Reasons for the Recommendations and Anticipated
Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1. General Statement of Committee's Recommendation to
Shift
From a Transactional Registration System to a Company
Registration System. . . . . . . . . . . . . . . . . . . . . . .
2. Identified Problems of the Current Transactional
System . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3. Company Registration as the Logical Conclusion of
Evolutionary
Change in the Regulatory Process . . . . . . . . . . . . . . . .
4. The Benefits of the Company Registration System as
Compared to the Current Transactional Regulatory
System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
B. Key Elements of the Recommendations
1. The Offering Process . . . . . . . . . . . . . . . . . . . . . . .
2. Prospectus Delivery Requirement. . . . . . . . . . . . . . . . . .
3. Scope. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4. Disclosure Enhancements. . . . . . . . . . . . . . . . . . . . . .
5. Liability. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6. Due Diligence. . . . . . . . . . . . . . . . . . . . . . . . . . .
7. Disclosure Committee . . . . . . . . . . . . . . . . . . . . . . .
III. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
IV. SEPARATE STATEMENT OF JOHN C. COFFEE, JR., EDWARD F. GREENE,
AND LAWRENCE W. SONSINI. . . . . . . . . . . . . . . . . . . . . . . . .
APPENDIX A: THE IMPACT OF THE CURRENT REGULATORY SYSTEM
ON INVESTOR PROTECTION AND CAPITAL FORMATION
I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
II. Direct and Indirect Costs and Uncertainties Resulting
From the Registration Process for Public Offerings . . . . . . . . . .
A. Costs of Registration - The Offering Process . . . . . . .
B. Indirect Costs Associated with the Current Regulatory Scheme
III. Changes in the Markets and Offering Processes, and the Effect on
Investor Protection. . . . . . . . . . . . . . . . . . . . . . . .
A. Attractiveness of Public, Private and Offshore Markets . . .
B. Blurring of Distinctions Between Public, Private and
Offshore Markets . . . . . . . . . . . . . . . . . . . . . .
C. Growth of Secondary Markets and Changes in Offering
Techniques . . . . . . . . . . . . . . . . . . . . . . . . .
D. Changes in Gatekeeper Role . . . . . . . . . . . . . . . . .
Addendums to Appendix A
APPENDIX B: ESSENTIAL ELEMENTS OF THE
COMPANY REGISTRATION SYSTEM
I. Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . .
A. Disclosure and Prospectus Delivery Under the Company
Registration System. . . . . . . . . . . . . . . . . . . .
B. Role of the SEC and Other Gatekeepers. . . . . . . . . . . .
II. Company Eligibility. . . . . . . . . . . . . . . . . . . . . . . .
III. Transactions Covered . . . . . . . . . . . . . . . . . . . . . . .
A. Affiliate and Underwriter Resales. . . . . . . . . . . . . .
B. Exclusions . . . . . . . . . . . . . . . . . . . . . . . . .
C. Offshore Offerings . . . . . . . . . . . . . . . . . . . . .
D. Preservation of Transactional Exemptions . . . . . . . . . .
E. Limited Placements . . . . . . . . . . . . . . . . . . . . .
IV. Disclosure Enhancements Under the Recommended Company
Registration Model . . . . . . . . . . . . . . . . . . . . . . . .
A. Mandatory Disclosure Enhancements. . . . . . . . . . . . . .
B. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . .
V. Liability and Due Diligence Under Company Registration . . . . . .
A. Liability Under Company Registration . . . . . . . . . . . .
B. Due Diligence Under Company Registration . . . . . . . . . .
C. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . .
Addendum to Appendix B -- Comparison of Company Registration and Shelf Offering
System
==========================================START OF PAGE 1======
COMMITTEE MEMBERS
The Honorable Steven M.H. Wallman, Committee Chairman
SEC Commissioner; former partner, Covington & Burling
Professor John C. Coffee, Jr.
Adolf A. Berle Professor of Law, Columbia University Law School
The Honorable Barber B. Conable, Jr.
Corporate director; former President, World Bank; former member,
U.S. House of Representatives; and former New York Stock Exchange
director
Robert K. Elliott
Partner, KPMG Peat Marwick LLP; Chair, AICPA Special Committee on
Assurance Services, and Member, AICPA's Board of Directors and
Governing Council
Edward F. Greene
Partner, Cleary, Gottlieb, Steen & Hamilton; former SEC General
Counsel; and former Director, SEC Division of Corporation Finance
Dr. George N. Hatsopoulos
Chairman of the Board and President, Thermo Electron Corporation;
and former Chairman, Federal Reserve Bank of Boston
A. Bart Holaday
Managing Partner, Private Markets Group and Member of the Board
of Directors, Brinson Partners, Inc.; and member of the board,
National Venture Capital Association
Paul Kolton
Corporate and fund director; former President and Chairman of the
American Stock Exchange; former Chairman, Financial Accounting
Standards Board's Advisory Council
Roland M. Machold
Director, New Jersey Division of Investment; former Vice
President, Morgan Stanley & Co.
Dr. Burton G. Malkiel
Professor of Economics, Princeton University and corporate and
fund director; former Dean, Yale School of Management; former
member, President's Council of Economic Advisers.
Claudine B. Malone
President of Financial & Management Consulting, Inc., and
corporate director; former Professor, Harvard Graduate School of
Business Administration
Charles Miller
==========================================START OF PAGE 2======
Chairman, Medallion Investment Management Company and Meridian
Advisors, Ltd.; corporate director; former Chief Investment
Officer, Transamerica Asset Management Group
Karen M. O'Brien
General Counsel, North American Securities Administrators
Association
Lawrence W. Sonsini
Partner, Wilson, Sonsini, Goodrich & Rosati; corporate director
COMMITTEE STAFF
David A. Sirignano, Committee Staff Director
Associate Director
Division of Corporation Finance
Dr. Robert Comment
Deputy Chief Economist
Office of Economic Analysis
Catherine T. Dixon
Chief, Office of Mergers and Acquisitions
Division of Corporation Finance
Meridith Mitchell
Assistant General Counsel
Office of the General Counsel
Luise M. Welby
Special Counsel
Office of International Corporate Finance
Division of Corporation Finance.
==========================================START OF PAGE i======
I. INTRODUCTION AND SUMMARY
A. Findings and Recommendations of the Committee
In February 1995, the Securities and Exchange Commission
(the "Commission" or "SEC") established the Advisory Committee on
the Capital Formation and Regulatory Processes (the "Committee").
Commissioner Steven M.H. Wallman was appointed by SEC Chairman
Arthur Levitt as the Committee's Chairman. The Committee was
authorized to advise the Commission on, among other things, the
current regulatory process and the disclosure and reporting
requirements relating to public offerings of securities, as well
as secondary market trading, and to identify and develop means to
minimize the costs imposed by existing regulatory
programs.-[1]-
The Committee determined to focus specifically on the
regulatory framework for securities offerings and continuing
disclosure by corporate issuers. Early in its deliberations, the
Committee concluded that the current procedures under the
Securities Act of 1933 (the "Securities Act")-[2]- are well
suited for companies that are engaging in an initial public
offering, i.e., a transaction in which a company is publicly
offering its securities for the first time. The Committee
determined, however, that the capital-raising activities of
---------FOOTNOTES----------
-[1]- Copies of the Committee's original Charter and
renewal Charter are attached in Appendix D.
-[2]- 15 U.S.C. 77a et seq.
==========================================START OF PAGE ii======
companies that have already offered their securities to the
public and are currently filing periodic reports with the
Commission pursuant to the Securities Exchange Act of 1934 (the
"Exchange Act")-[3]- have changed dramatically and
fundamentally over the last half century. Consequently, the
Committee primarily focused its attention on identifying issues
and crafting solutions related to those activities.
The Committee initially identified certain aspects of the
current transactional registration approach of the Securities Act
that, at least as applied to reporting companies, may adversely
affect investor protection and the capital formation process.
The Committee then explored alternative regulatory strategies
that would: (i) enhance investor protection by extending and
reinforcing the protections of the Securities Act; (ii) improve
the efficiency of access by such companies to the U.S. capital
markets; (iii) eliminate unnecessary regulatory costs and
uncertainties for issuers; and (iv) enhance the quality and
integrity of disclosures provided to investors in both the
primary offering and secondary trading markets.-[4]- The
Committee generally concluded that, in order to achieve these
---------FOOTNOTES----------
-[3]- 15 U.S.C. 78a et seq.
-[4]- The Committee staff also examined foreign
regulatory schemes relating to public offerings of
securities for guidance with respect to possible
alternative regulatory approaches, particularly
with respect to offerings by seasoned issuers.
See Documents for Advisory Committee Meeting, June
15, 1995, Tab F (the Committee staff's study of
certain foreign regulatory schemes).
==========================================START OF PAGE iii======
goals, the focus of the regulatory process in the post-initial
public offering context should be shifted from registering
transactions to registering companies, with a corresponding
emphasis on better ensuring the accuracy and integrity of
continuing disclosures. As a consequence of this conceptual
shift, once a company is registered and filing the required
public reports, all the securities that the company or its
affiliates sell thereafter would be deemed registered for
purposes of the Securities Act, investors would be more fully
protected in more transactions, and the issuer would be able to
offer and sell its securities without any regulatory delay in
virtually all cases.
The Committee next developed a package of concepts -- under
the label "company registration" -- to accomplish this shift in
regulatory focus. At the request of the Committee, the Committee
staff created a working "Term Sheet" describing possible company
registration models to be implemented on an experimental or
"pilot" basis, which the Committee used as an evolving framework
for consideration and discussions at Committee
meetings.-[5]- The model includes measures designed both to
streamline the offering and disclosure processes, and to improve
the timeliness, quality, reliability and integrity of information
provided to investors and other participants in the securities
---------FOOTNOTES----------
-[5]- The most recent Term Sheet outlining a model for a
pilot program to test the company registration
concept is attached as Appendix C to this Report.
==========================================START OF PAGE iv======
markets. Based upon Committee deliberations, as well as
Committee and staff consultations with representatives of the
investor, issuer, underwriter, legal, accounting and academic
communities, the Committee concluded that the proposed company
registration system would reduce substantially unnecessary
regulatory costs and burdens for issuers while enhancing investor
protection.
As discussed more fully in the balance of this Report, the
Committee determined that a pilot company registration program
would be the most appropriate way to begin the transition. The
pilot would be available initially only to issuers that meet
certain criteria, such as having a specified minimum public float
and reporting history. Because these issuers generally are more
sophisticated with respect to financial reporting and other
disclosure requirements and are more widely followed by the
markets, the Committee concluded that permitting these types of
issuers to opt into the pilot program would provide the best test
of the advantages of the company registration system as compared
to the current system. If the pilot is successful, the Committee
believes that the Commission should extend the benefits of
company registration, perhaps with additional conditions, to
smaller public companies and their investors as soon as possible.
The streamlining of the offering process will result from
the adoption of a new registration procedure under which the
company would register to enter into the system (on a new Form C-
1 registration statement). Thereafter, each issuance by the
==========================================START OF PAGE v======
registered company of its securities would be deemed registered
under the Securities Act, including securities issued in
acquisitions and securities initially sold offshore that flow
back into the United States, with all the protections and
remedies that currently adhere to a registered transaction. A
registration fee would be paid to the Commission at the time of
each sale of securities, rather than at the time of filing of the
Form C-1 (thereby creating a "pay-as-you-go" system). As a
result, the current limitations of the shelf registration system
on the amount of securities that could be registered would be
eliminated, as would the need to file a new registration
statement to register additional securities. This process also
would eliminate the uncertainties and delay in the offering
process resulting from the potential for Commission staff review
prior to a registration statement being declared effective.
Such uncertainty and delay has already been eliminated in the
context of takedowns from an already effective shelf registration
statement, but not with respect to the initial effectiveness of
the shelf registration statement.
Under company registration, the nature and amount of
information about the company and its securities required to be
on file with the Commission at the time of sale would be at least
as extensive as that now required under the current Securities
Act registration forms. Provided all mandated information has
been disclosed to the markets, issuers in routine transactions
would be permitted to tailor the disclosure physically delivered
==========================================START OF PAGE vi======
to investors in a prospectus as necessary to meet the
informational demands of investors in light of the nature of the
transaction, as assessed by the issuer and underwriter in
marketing the securities. Consequently, the information provided
to investors should be both more readable (in plainer English)
and more useful (because it is tailored to the investors' needs).
Moreover, under a "full" company registration system where all
securities are registered, a reduction in the scope of the resale
restrictions applicable to affiliates is possible and desirable
because subjecting these holders to resale restrictions would
serve no purpose since all the securities are already registered.
As a result, most directors and officers will no longer be
subject to resale restrictions.
The investor protection improvements of the company
registration system will deliver benefits both at the time of the
offering and on an ongoing basis. In most equity offerings,
information regarding the specific transaction and any material
developments will be filed with the Commission, and therefore
made available to all investors and the markets, no later than
the date of first sale (material developments will have to be on
file in sufficient time for the market to absorb the information
before the sale is made), rather than as late as two days after
the delivery of the prospectus as permitted under the current
shelf registration system. This reform will serve a number of
beneficial purposes. First, it ensures that the market receives
timely notice of material developments, thereby providing the
==========================================START OF PAGE vii======
market sufficient opportunity to react to the information prior
to investors making an investment decision. Second, it will
assist underwriters and others with due diligence
responsibilities to focus on the information important to the
offering and help ensure that it is fully and accurately
disclosed. Third, it will extend full coverage of the statutory
liability provisions to this important information. In addition,
in those large offerings where issuers will be required under the
model to deliver a formal prospectus, the prospectus must be
delivered to a potential investor in time to inform the
investment decision. Under current procedures, the prospectus
can be delivered with the confirmation, well after an investor
has already made an investment decision.
Various measures designed to improve the quality and
integrity of a registered company's disclosure on an ongoing
basis are part of the recommended company registration system.
These measures include improved procedures to focus the attention
of management and the board of directors on the periodic and
other reports prepared and filed by the company, and to provide
for more timely disclosure of material developments. For the
first time, risk factor disclosure will be provided to investors
in the secondary trading markets through the company's annual
report on Form 10-K filed with the Commission. In addition, the
company registration system will create incentives for the
reordering and rationalization of "information monitoring" or
"gatekeeping" functions to provide greater oversight of the
======================================START OF PAGE viii======
issuer's disclosures on an ongoing basis. The system does so by,
among other things, specifying additional factors that may be
taken into consideration in satisfying the due diligence and
reasonable care defenses of certain gatekeepers or monitors under
Sections 11 and 12(a)(2) of the Securities Act. By enhancing the
quality and integrity of disclosure and thereby reducing the
likelihood of material misstatements and omissions by the issuer
and others engaged in a public offering, the model also should
operate, as a practical matter, to decrease the liability
exposure of these parties.
In connection with its deliberations on company
registration, the Committee also examined the concept of
encouraging a company's board of directors to adopt a board
"disclosure committee" (which could be the audit committee).
This concept has as its goal enhancing the reliability and
integrity of an issuer's public disclosures, by promoting better
and more intensive due diligence on the part of outside directors
on an ongoing basis. This separate recommendation of the
Committee, which could be effectuated regardless of whether
company registration is adopted (and, conversely, company
registration could be adopted regardless of whether the
disclosure committee concept is embraced), also is discussed in
this Report.
B. The Work of the Committee and Structure of the Report
The Committee held eight public meetings. The Committee and
its staff also met with numerous groups and individuals concerned
==========================================START OF PAGE ix======
with or affected by the Commission's regulation of the capital
formation process. The Committee wishes to acknowledge with deep
appreciation the thoughtful comments and insights provided by
these groups and individuals. The letters and articles submitted
by commenters for the benefit of the Committee are available from
the SEC Public Reference Room, File No. 265-20.
Except with respect to certain recommendations to improve
the quality and integrity of periodic reporting under the
Exchange Act, the Committee determined not to address specific
line-item requirements prescribing the content and manner of
presentation of disclosure documents filed with the Commission.
An internal Commission task force, known as the Task Force on
Disclosure Simplification, has reviewed these requirements, and
recently published a report recommending that the Commission
eliminate 91 rules and 22 forms, and modify dozens of
others.-[6]- Separately, the Commission also initiated
rulemaking addressing several issues raised by Committee members
in the course of the Committee's deliberations.-[7]- The
---------FOOTNOTES----------
-[6]- See Report of the Task Force on Disclosure
Simplification to the Securities and Exchange
Commission (March 5, 1996).
-[7]- For example, improving the safe-harbor for
forward-looking statements was a significant
concern of some members of the Committee, a matter
which already was under consideration by both the
Commission and Congress during the deliberations
on the Private Securities Litigation Reform Act of
1995, enacted in late 1995 (Pub. L. No. 104-67
(December 22, 1995)); see also Safe Harbor For
Forward-Looking Statements, Securities Act Rel.
7101 (October 13, 1994)[59 FR 52723 (October 19,
(continued...)
==========================================START OF PAGE x======
Committee also determined at the outset of its deliberations to
focus on issues regarding the application of the Securities Act
to companies that are reporting under the Exchange Act. The
Commission already was pursuing many issues affecting non-
reporting companies that access the securities markets for
capital pursuant to various Securities Act exemptions.-[8]-
Consequently, these specific issues and policies are not
addressed in this Report.
The Committee's recommendations are presented in two main
parts in this Report. Section IIA of the Report contains a
---------FOOTNOTES----------
-[7]-(...continued)
1994)]. Various Committee members also were
critical of the Commission's rules under the
Securities Act requiring the disclosure of
financial and other business information about
material acquisitions or dispositions. The
Commission has now proposed conforming those rules
under the Securities Act to the requirements under
the Exchange Act. See Streamlining Disclosure
Requirements Relating to Significant Business
Acquisitions and Requiring Quarterly Reporting of
Unregistered Equity Sales, Securities Act Rel.
7189 (June 27, 1995)[60 FR 35656 (July 10, 1995)].
-[8]- For example, numerous Committee members suggested
that the Commission seek ways to facilitate
capital formation by small businesses. In June
1995, the Commission issued a proposal regarding a
"test the waters" provision with respect to
initial public offerings to allow private
companies contemplating a public offering to
ascertain whether their securities are marketable
before preparing expensive registration
documentation. See Solicitations of Interest Prior
to an Initial Public Offering, Securities Act Rel.
7188 (June 27, 1995)[60 FR 35648 (July 10, 1995)];
see also the recently adopted Exemption for
Certain California Limited Issues, Securities Act
Rel. 7285 (May 1, 1996)[61 FR 21356 (May 9,
1996)].
==========================================START OF PAGE xi======
general discussion of the Committee's recommendation that the
Commission shift its regulatory focus from the registration of
securities transactions to the registration of companies, and the
reasoning underlying that recommendation. Appendix A to the
Report provides more detailed support for the Committee's
recommendations. It also includes data and empirical research on
the effects of the current regulatory scheme governing public
offerings on investor protection and capital formation in the
U.S. markets. In addition, Appendix A discusses the various
costs and uncertainties of the current transactional process for
Exchange Act reporting companies. It reviews the increasingly
complex and technical regulatory concepts that have become
necessary to protect the current transaction-based paradigm in
light of significant shifts in investor demographics, market
structure and communications technology, and describes how these
concepts may no longer be achieving their intended goals of
protecting investors. Appendix A concludes with a discussion of
the blurring among and between the public, private and offshore
markets, and the fundamental changes in both the composition of
these markets and their participants since the enactment of the
federal securities laws more than sixty years ago.
Section IIB of the Report includes a summary description of
the recommended terms of the company registration system and the
suggested pilot project, as well as the Disclosure Committee
proposal. Appendix B to the Report, in turn, describes in more
detail each of the essential elements of the company registration
==========================================START OF PAGE xii======
system -- with respect both to the recommended pilot and full
company registration system -- and explores further the support,
reasoning and rationale underlying each recommended element.
Finally, a concurring statement by Committee members John C.
Coffee, Jr., Edward F. Greene, and Lawrence W. Sonsini is set
forth in Section IV of the Report.
======================================START OF PAGE xiii======
COMPANY REGISTRATION PILOT AT A GLANCE
Essential Elements
A. Offering Process -- Further liberalization of shelf
registration process; pay upon issuance fee system; no limit
as to number or dollar amount of securities registered;
available for acquisitions; prospectus delivery simplified.
B. Disclosure Enhancements -- Improve level and reliability of
information provided to primary and secondary trading
markets through (i) measures such as senior management
review of disclosure and management reports on procedures
for disclosure preparation; (ii) more current disclosure of
significant developments; and (iii) earlier filing of
transactional information than under current requirements.
C. Enhanced Monitor or Gatekeeper Functions -- Maintain current
liability scheme while providing additional guidance
regarding due diligence obligation to emphasize roles of
parties involved with the company on a continuous basis and
to facilitate greater involvement by certain "gatekeepers"
or "monitors" in disclosure oversight.
==========================================START OF PAGE xiv======
D. Enhanced Investor Protections -- In addition to B and C
above, extend statutory liability to documents and
transactions that currently lack such protections.
E. Scope -- Voluntary system available to seasoned issuers
during initial pilot; covers all offerings of nonexempt
securities, eliminating need for the concept of "restricted"
securities and limiting application of resale restrictions
to a narrower subset of affiliates, and permitting narrower
application of the statutory underwriter concept; issuers
can elect less comprehensive pilot system preserving
exemption for private placements, but then apply current
restrictions on resales of privately placed securities,
including current broader application of affiliate and
statutory underwriter requirements.
Goals, Benefits, and Effects
A. Eliminate unnecessary regulatory costs and uncertainties
that impede access to capital; instead, market
considerations, rather than regulatory concerns, will govern
timing of offering; eliminate mandatory waiting period and
potential for prior SEC staff review of routine transactions
that now add cost and uncertainty.
==========================================START OF PAGE xv======
Greater flexibility to go to market more often in lesser
amounts in light of lower transaction costs and less delay
and uncertainty -- will facilitate adoption of "just-in-time
capital" techniques; alleviate market overhang effect that
may still result from placing equity on a universal shelf;
elimination of a separate registration requirement for
acquisitions.
Greater flexibility in defining nature of marketing efforts:
timing and content of prospectus disclosure delivered to
investors driven primarily by informational needs of
investors, rather than need to prepare and deliver after-
the-fact compliance documents; more flexibility in
negotiating transactions because regulatory constraints
significantly diminished.
B. Reduce complexities and pricing discounts arising from the
need to distinguish between public and private, domestic and
offshore, and issuer and non-issuer transactions, including
concerns regarding gun-jumping, integration, general
solicitation, restricted securities, and other constructs
developed over the years to maintain the separation of the
public and private markets.
C. Maintain and enhance the protection of investors in the
primary and secondary trading markets with disclosure
==========================================START OF PAGE xvi======
enhancements resulting in better due diligence practices and
heightened level and reliability of corporate reporting;
statutory remedies extended to more disclosure and to a
broader class of transactions.
D. Eliminate affiliate-type resale requirements for most
officers and directors; provide additional guidance as to
what constitutes "reasonable investigation" and "reasonable
care" in context of the integrated disclosure and
streamlined offering process.
II. RECOMMENDATIONS OF THE ADVISORY COMMITTEE
A. Reasons for the Recommendations and Anticipated Benefits
1. General Statement of Committee's Recommendation to
Shift From a Transactional Registration System to a
Company Registration System
In the Committee's view, the U.S. capital markets are deep,
liquid, efficient and reliable and, overall, the U.S. regulatory
system for securities offerings works relatively well. While
concluding that the system is not broken, the Committee believes
that there is room for improvement. In the words of one member,
"some fixing would make the system work even better."-[1]-
The fact that the primary equity markets have not demonstrated
any long-term upward trend as a source of capital since 1933,
despite the fact that real Gross Domestic Product has tripled
during that period,-[2]- amply justifies an inquiry into
possible regulatory inefficiencies. In this regard, the
Committee identified various uncertainties, complexities and
anomalies in the current transactional system that unduly burden
capital formation for issuers without providing significant
---------FOOTNOTES----------
-[1]- Transcript of May 8, 1995 Advisory Committee
meeting at 155 (statement of Dr. Burton Malkiel).
Indeed, as noted by one commenter, the "strength
of our current capital markets serves as a
testament to the existing securities legislation,
related regulations, and interpretations."
Documents for Advisory Committee Meeting, May 8,
1995, Tab I (Letter dated April 10, 1995 from
Michael A. Conway, Senior Partner, KPMG Peat
Marwick LLP to the Committee).
-[2]- See Figures 1 and 2 in the Addendum to Appendix A
of the Report.
==========================================START OF PAGE 2======
offsetting benefits to investors, and other anomalies that
operate to deny needed investor protections. Although
recognizing the past and ongoing efforts of the Commission to
address these concerns through incremental regulatory reform, the
Committee strongly believes that the time has come for a
fundamental conceptual change in the scheme of regulation
governing public offerings.-[3]-
The Committee views a shift to company registration as the
most logical culmination of the evolving recognition over the
past thirty years by the Commission, commentators, the courts and
market participants, of the need for reform. Specifically, it
has long been recognized that a disclosure scheme dependent on
infrequent, unpredictable and episodic offering transactions to
provide continuous and current, high quality disclosure to
investors and the public markets is not optimal. Stated
differently, a regulatory structure that focuses on such
transactions is neither efficient nor does it necessarily serve
---------FOOTNOTES----------
-[3]- A number of expert commentators similarly have
called for fundamental reform of the current
regulatory system. See, e.g., Roberta Karmel, Is
Section 5 an Anachronism?, N.Y.L.J., December 21,
1995, at 3; John C. Coffee, Jr., Is the Securities
Act of 1933 Obsolete? The SEC Increasingly
Appears to Believe So But Has Not Yet Adopted a
Consistent Policy to Replace It, Nat'l L. J.,
September 4, 1995, at B4; Gerald S. Backman and
Stephen E. Kim, A Cure for Securities Act
Metaphysics: Integrated Registration, INSIGHTS,
May 1995, at 18; Joseph McLaughlin, 1933 Act's
Registration Provisions: Is Time Ripe for
Repealing Them?, Nat'l L. J., August 18, 1986, at
44.
==========================================START OF PAGE 3======
the public interest well, especially in light of the relative
size -- 35 times larger -- of the equity trading markets
(approximately $5.5 trillion dollars in 1995) as compared to the
primary markets (approximately only $155 billion in
1995).-[4]-
If the regulatory focus is shifted to a company registration
model that would replace the transactional registration
requirements, issuers would benefit from the elimination of the
increasingly complex, but often ineffective, series of
regulations and concepts fashioned over the years to preserve
those transactional requirements. Eligible companies would have
easier access to the capital markets with lower regulatory and
transaction costs, enabling companies to tap the equity markets
far more often than they do now. Equally as important, adoption
of a company registration system would allow the Commission to
eliminate those anomalies under the current system that function
to deny investors the protections originally contemplated by the
Securities Act, and to make the necessary adjustments to
secondary market disclosure practices and due diligence
responsibilities that would benefit investors and provide better
continuous disclosures to the markets.
The Committee recognized that the task of streamlining and
simplifying the current regulatory system would be beneficial.
Likewise, enhancing investor protection is always desirable.
---------FOOTNOTES----------
-[4]- See Figure 2 in the Addendum to Appendix A of the
Report.
==========================================START OF PAGE 4======
Each of these goals could be accomplished easily at the expense
of the other by dispensing with or adding burdens, restrictions,
or liability. However, the Committee assumed the far more
difficult task of crafting a system that both streamlines and
simplifies the offering process, thereby lowering costs, while
also enhancing investor protection and the integrity of corporate
disclosures. The Committee believes that this company
registration model, which would accomplish both goals, is
superior to an approach that accomplishes only one. The
Committee's approach represents a different concept in regulatory
problem-solving -- crafting a whole model -- as opposed to
effecting incremental changes to particular regulations.
The recommendations of this Committee build upon the work of
prior Commission committees and task forces,-[5]- and upon
the work of Professor Louis Loss and other members of the
American Law Institute in connection with its Federal Securities
Code.-[6]- That the time has come to complete the
transition to a company registration scheme is underscored by the
fact that the ALI Code -- including its centerpiece proposal for
---------FOOTNOTES----------
-[5]- See, e.g., Report of the Advisory Committee on
Corporate Disclosure to the Securities and
Exchange Commission, 95th Cong., 1st Sess. (Comm.
Print 1977) (the "1977 Advisory Committee
Report"); Disclosure to Investors, A Reappraisal
of Administrative Policies Under the 1933 and 1934
Acts, Report and Recommendations to the SEC from
the Disclosure Policy Study (March 27, 1969) (the
"Wheat Report").
-[6]- Federal Securities Code (Am. Law Inst.) (1980)
(the "ALI Code").
==========================================START OF PAGE 5======
company registration -- was endorsed by two separate Commissions
in 1980 and 1982.-[7]- Experience in the intervening decade
has only reinforced the advisability of modernizing the current
system. The Committee urges the present Commission to complete
the transition to a system of company registration, thereby
freeing the markets of the costs, uncertainties and confusion
engendered by the current transactional registration scheme.
The Commission's ultimate goal should be the implementation
of a system of company registration that totally replaces the
current transactional registration concept for all reporting
companies. In order to test most effectively the feasibility of
the company registration model, however, the Committee recommends
that the Commission establish a pilot program that would be open
initially only to certain "seasoned" issuers on a voluntary
basis. The Committee has suggested the general framework of the
pilot system, recognizing that the Commission has the expertise
to craft the details. As the Commission and issuers gain
experience under the new system, it could be refined if necessary
and then, with appropriate modifications, be made available to a
broader class of issuers. Once the company registration system
has sufficiently demonstrated its benefits during the pilot,
---------FOOTNOTES----------
-[7]- Statement Concerning Codification of the Federal
Securities Laws, Securities Act Rel. 6377 (January
21, 1982); Statement Concerning Codification of
the Federal Securities Laws, Securities Act Rel.
6242 (September 18, 1980).
==========================================START OF PAGE 6======
regulatory simplification could be completed through rulemaking
and/or legislative changes, as necessary or appropriate.
2. Identified Problems of the Current Transactional
System-[8]-
The Committee identified uncertainties, complexities and
anomalies in the current transactional registration system that
increase costs of capital formation when a public trading market
already exists for an issuer's securities and adequate
information concerning the issuer is widely disseminated and
followed in that market, without providing significant
countervailing benefits to investors. These costs are both
direct and indirect.
a. Procedural Requirements of the Registration
Process
Statutory limitations and regulatory restrictions on
solicitation activities prior to and during the registration
process make it difficult for reporting companies to distinguish
between permitted and prohibited market communications.
Companies and other offering participants therefore have limited
their ordinary-course market communications unnecessarily when
contemplating or conducting a public offering. In the event of
improper soliciting activities (called "gun-jumping"), the
Commission may delay an offering, resulting in a possible loss of
a temporary market opportunity. The ability of an issuer to
---------FOOTNOTES----------
-[8]- For a more in-depth discussion of the issues
outlined in this section, see Appendix A to the
Report.
==========================================START OF PAGE 7======
control the timing of its public offering, and therefore its
ability to take advantage of a favorable market opportunity, also
is affected by both the uncertainty of selection of its
registration statement for Commission staff review and the length
of the resultant delay if so selected. This uncertainty
continues to impact even those companies eligible to register
securities under the shelf registration system, who may wish to
make immediate offerings, or "takedowns," after filing the shelf
registration statement, but who must wait until any possible
staff review of the registration statement is complete, before
takedown is permitted.
In addition, the mandatory nature of the prospectus delivery
obligation in connection with a registered offering under the
current system restricts the ability of the issuer to tailor the
required document to suit the varying needs of prospective
investors. Moreover, and perhaps more importantly, prospectus
disclosure under the current system frequently is not even
received by investors until after an investment decision is made.
This anomaly defeats the primary purpose of mandated prospectus
delivery -- that investors receive all information material to an
investment decision before making that decision.
Similarly, under the current system, the prospectus
supplement is not required to be filed with the Commission until
two days after it is delivered to investors in the primary
offering. Although the purchasers may have received key pricing
and other transactional information orally from participating
==========================================START OF PAGE 8======
broker-dealers at the time of takedown, the market frequently
does not have the information contained in the prospectus
supplement until days after completion of the shelf offering.
Thus, investors trading in the secondary markets
contemporaneously with a shelf offering do not have equal access
to material information until after their trading decision is
made, even though their investment decision takes place at the
same time as the primary offering.
Perhaps more importantly, one of the central tenets of the
current shelf process -- namely the existence of an efficient
market for the issuer's securities that helps establish the price
for those securities -- is violated because the market does not
have timely access to this prospectus supplement information.
Consequently, to the extent the market is being relied upon to
help set the price for the primary offering, it is being denied
the full information it needs to do so. This disparity in the
regulatory system exists because, under the current transactional
registration system, the focus is on information given to
purchasers in the offering, not the market. Under the company-
focused approach, by contrast, there is a greater concern for the
quality and timeliness of information available to the market and
all investors.
Further driving the need to reassess this process is the
development of new technologies that are changing rapidly the way
in which information is communicated and disseminated in our
markets. Present and future changes in technology, particularly
==========================================START OF PAGE 9======
in light of the advent of T+3 clearance and settlement,
electronic dissemination of offering documents, and the
development of trading markets over the Internet, can only
continue to challenge the current system.
Finally, the registration process itself imposes direct
expenses on an issuer in the form of legal, accounting,
underwriting, printing and filing fees, as well as indirect costs
due to the effects of market overhang and short-selling and
related activities on the market price of an issuer's securities
traded in the secondary markets. Under a company registration
system that allows "just-in-time" financing techniques, these
costs should be reduced.
==========================================START OF PAGE 10======
b. Technical Distinctions and Concepts Designed to
Protect the Integrity of the Transactional
Registration Paradigm
While originally devised to prevent evasion of the
transactional registration requirements, the technical
distinctions and concepts developed by regulation and/or
interpretation over the years -- such as "restricted" securities,
integration of offerings and limitations on general solicitations
-- have added a significant degree of confusion and uncertainty,
as well as constraints and costs, to the capital formation
process. These concepts and requirements increasingly have been
condemned as "metaphysics,"-[9]- and are among the reasons
why issuers often offer securities in the private and offshore
markets. Public companies that today wish to avoid the
disadvantages of the current registration scheme currently bear
the burden of an illiquidity discount in private placements of
securities or the additional logistical burdens of an overseas
offering. In the case of seasoned companies, these restrictive
concepts have limited practical or economic substance in terms of
investor protection. Given that they drive seasoned companies to
markets where there are in fact little or no Securities Act
investor protections, these concepts are increasingly difficult
to defend on a legal, economic or investor protection basis.
---------FOOTNOTES----------
-[9]- See, e.g., Stanley Keller, Basic Securities Act
Concepts Revisited, INSIGHTS, May 1995, at 5;
Gerald S. Backman and Stephen E. Kim, A Cure for
Securities Act Metaphysics: Integrated
Registration, INSIGHTS, May 1995, at 18.
==========================================START OF PAGE 11======
c. Changes in the Markets and Offering Processes, and
the Effect on Investor Protection
While the public, private and offshore markets are still
treated as technically distinct and separate markets under the
Securities Act, the traditional boundaries between and among such
markets have increasingly become blurred and distorted by
technological advances and evolving trading practices. The
Committee questions whether the regulatory distinctions drawn
between and among these markets should, or can, be maintained for
seasoned issuers. Through the use of such strategies as hedging
techniques, equity forwards, and equity swaps, and so-called "A/B
exchange offers" and "PIPE" transactions-[10]- that the
Committee believes promote form over substance, the vital
investor protection concepts underpinning the Securities Act are
losing their effectiveness. Simply put, through these
techniques, issuers in essence can engage in public offerings
without providing investors with the benefits and remedies of the
Securities Act at the time of the investment decision.
The nature of our securities markets has changed
dramatically over the last sixty years. The rate of change has
been even more striking in the last two decades. In the
Committee's view, the statutory schemes first enacted in 1933 and
---------FOOTNOTES----------
-[10]- For an explanation of these devices and additional
information regarding the blurring of public,
private, domestic and offshore markets and the
consequent effects on investor protection, see
Appendix A to the Report at p. 38-45.
==========================================START OF PAGE 12======
1934 were well adapted to the markets of the time.-[11]-
Sixty years ago, the secondary trading markets for equity were
far smaller and less active than they are today -- only a few
times the size of the primary markets, as opposed to 35 times
today -- and there were few mechanisms for the general public to
make investments other than through the direct purchase of
corporate shares in primary offerings.
Since then, trends such as the growth in the secondary
trading markets for equity relative to the primary issuance
market, the general shift of retail investor participation from
the primary markets to the secondary markets, and the increasing
institutionalization of the markets for both debt and equity,
have called into question whether the current statutory
provisions of the Securities Act continue to protect investors as
efficiently and effectively as possible. In addition,
---------FOOTNOTES----------
-[11]- For example, during the 1930s and 1940s, on
average, the number of registration statements
declared effective on a yearly basis was
approximately 400 as compared to over 8,000 today
(including all registration forms). Annual Report
of the Securities and Exchange Commission for the
fiscal years 1935 through 1950; Division of
Corporation Finance data.
In the past, companies tapped the equity markets only when
necessary because costs were extremely high. Prospectuses,
even for the most seasoned issuers, were fully stand-alone
documents presenting an entire picture of a company, without
incorporation by reference to other disclosure documents.
Offerings frequently took months to complete, and the
process for seasoned issuers was not very different from the
process for an initial public offering. Moreover, the SEC
Commissioners themselves would actually meet to review the
few registration statements that were submitted each week
and provide written comments on the disclosure presented in
the registration statement.
==========================================START OF PAGE 13======
evolutionary changes in the rules governing the offering process
made by the Commission over time to facilitate issuer access to
the markets, including the increased reliance on Exchange Act
reports to satisfy many core Securities Act disclosure
requirements, the adoption of shelf registration for primary
offerings and the timing of prospectus delivery, may be impairing
the ability of issuers' boards of directors, underwriters and
independent accounting firms to perform their traditional
Securities Act "due diligence."
3. Company Registration as the Logical Conclusion of
Evolutionary Change in the Regulatory Process
Past initiatives demonstrate that, while also enhancing
investor protection, cost savings can be anticipated from a
transition to a company registration system. In this regard, the
Committee does not write on a blank slate. Almost thirty years
ago, Milton Cohen described the need for a dramatic
transformation in focus and thinking regarding the regulatory
structure of the federal securities laws, when he wrote:
[i]t is my thesis that the combined disclosure
requirements of [the Securities Act and the Exchange
Act] would have been quite different if the [Acts] had
been enacted in opposite order, or had been enacted as
a single, integrated statute -- that is, if the
starting point had been a statutory scheme of
continuous disclosures covering issuers of actively
traded securities and the question of special
disclosures in connection with public offerings had
then been faced in this setting. Accordingly, it is my
plea that there now be created a new coordinated
disclosure system having as its basis the continuous
disclosure system of the [Exchange] Act and treating
==========================================START OF PAGE 14======
"[Securities] Act" disclosure needs on this
foundation.-[12]-
Further suggestions regarding the integration of the disclosure
and regulatory schemes of the Securities Act and Exchange Act --
actions moving towards a company registration model -- were
raised in the 1969 Wheat Report,-[13]- the 1977
recommendations of the SEC's Advisory Committee on Corporate
Disclosure,-[14]- and the ALI Code.-[15]- As a
result, the integrated disclosure system and the shelf
registration process were implemented by the Commission in the
early 1980s, and have now firmly taken hold and demonstrated
their benefits.
Moreover, with the adoption of Rule 144A in 1990, the
Commission began the development of a limited institutional
trading market in certain restricted securities, thereby
permitting greater liquidity and a lower illiquidity discount,
and consequently reducing the regulatory costs imposed by resale
restrictions on these securities. Similar to public offerings,
Rule 144A placements generally are conducted with the assistance
of investment banking firms. In addition, Rule 144A placements
often involve the use of detailed offering circulars making
---------FOOTNOTES----------
-[12]- Milton H. Cohen, "Truth in Securities" Revisited,
79 Harv. L. Rev. 1340, 1341 - 1342 (1966).
-[13]- Wheat Report, supra n.5.
-[14]- 1977 Advisory Committee Report, supra n.5.
-[15]- ALI Code, supra n.6.
==========================================START OF PAGE 15======
extensive disclosures regarding the offering as well as the
company and its financial condition. This is the case even
though there are no explicit Commission-mandated disclosure
requirements applicable in a Rule 144A placement.-[16]-
Due to the innovative ideas of integrated disclosure
(including incorporation by reference), short-form shelf
registration and Rule 144A, offerings today can be conducted on a
more cost-efficient basis than under the traditional model for
underwritten public offerings:
Under the current selective review system, the majority
of registration statements relating to public offerings
by seasoned issuers are not reviewed by the
Commission's staff prior to effectiveness. Moreover,
in the case of primary shelf offerings, the information
contained in prospectus supplements is never required
to be pre-reviewed by the staff prior to the takedown
of securities from the shelf.
A shelf registration statement need not describe in
advance a specific contemplated offering. Since 1992,
issuers have been able to complete an offering under a
universal shelf registration statement that
simultaneously registers an unspecified amount of each
enumerated type of security registered, subject only to
the unallocated total dollar amount of securities being
registered and a presumed two-year limit on the amount
reasonably expected to be offered.
The traditional methods of prospectus delivery are not
necessary in connection with all public offerings.
Today, in the case of offerings by seasoned issuers,
much of the crucial company-related information is
incorporated by reference from the company's filed
reports, rather than physically delivered to investors
as part of the prospectus.
The success of the Rule 144A institutional market
evidences that an active primary issuance market can
---------FOOTNOTES----------
-[16]- Of course, the general antifraud provisions of the
federal securities laws still apply.
==========================================START OF PAGE 16======
develop, with procedures and disclosure documents
delivered to investors that better suit their needs, in
the absence of a mandated Securities Act transactional
registration process, and disclosure delivery
requirements.
That the Commission already has travelled so far from the
original transactional disclosure model does not imply, however,
that there is nothing more to be done to enhance investor
protection and facilitate capital formation. It should be noted
that, at each phase in the development of the current system,
this country's securities markets were functioning well and were
the deepest, most liquid and largest of any in the world. With
each transition to a new phase, the markets improved. The
favorable experience with these reforms illustrates that issuers,
under the proper conditions, can be freed from many of the
constraints of the transactional registration process not only
without undermining the Securities Act's investor protection
goals but also, if appropriately and thoughtfully done, by better
satisfying them. The overall success of the current integrated
disclosure and shelf offering systems, and the Rule 144A market,
provides the Commission with a solid foundation for making
additional improvements to facilitate issuer access to the U.S.
public markets consistent with these goals.
4. The Benefits of the Company Registration System as
Compared to the Current Transactional Regulatory
System
The reforms that would be instituted under the proposed
company registration system are part of this ongoing evolutionary
process. Transactions under company registration would not
==========================================START OF PAGE 17======
differ significantly from transactions under the current
universal shelf system, in the sense that the issuer in advance
of an offering need only describe its financing plans in general
terms, and would not be subject to a separate registration
process and staff review when it wishes to proceed to market.
There will, however, be significant advantages for the issuer and
its shareholders over the current shelf system because the
company registration system essentially will make the Form C-1
the equivalent of a shelf registration statement that is
applicable on a continuous basis for all future offerings. The
various elements of company registration that will effect this
change include the pay-as-you-go fee system, the elimination of
the need to register a specified amount of securities in advance
(which should alleviate the concerns regarding equity market
overhang that persist notwithstanding the adoption of the
unallocated or "universal" shelf procedure), as well as the
extension of the streamlined offering process to most
acquisitions. Smaller, more frequent, offerings likewise will be
facilitated by the simplicity and ease of the company
registration system. In addition, elimination of current
restrictions on at-the-market equity offerings will eliminate the
lingering confusion surrounding this concept.
Moreover, issuers should realize significant cost savings as
a result of the more flexible prospectus delivery requirements,
while maintaining, and even enhancing, the nature and amount of
disclosure on file with the Commission and hence disclosed to the
==========================================START OF PAGE 18======
markets at the time of sale. Finally, the full company
registration system eliminates the unnecessary application of
resale restrictions on most directors and officers.
Company registration also would offer issuers and investors
significant advantages over Rule 144A:
all the speed and predictability of a Rule 144A
offering;
no illiquidity discount, which generally now
attaches to restricted (unregistered) securities;
offering not limited to a prescribed class of
qualified institutional buyers;
offered securities not limited by fungibility
restrictions;
satisfaction of investor demand for registered
securities;
investors afforded the Securities Act protections
of a registered transaction; and
avoidance of uncertainties arising from potential
integration with non-144A offerings.
Unlike the current shelf rule and even Rule 144A, full
implementation of a company registration model would simplify the
complex regulatory quilt of rules and doctrines that has been
patched together in an effort to preserve the transactional focus
of the existing regulatory scheme and its core registration
requirement. Thus, the need to superimpose legal distinctions on
economically indistinct markets would be eliminated.
At the same time, and as important, company registration
would provide an opportunity to buttress the fundamental investor
protections that have come under increasing stress as the markets
have experimented with more efficient offering methods, some of
==========================================START OF PAGE 19======
which are outside the scope of the Securities Act altogether. As
efforts have been made to accommodate demands for more
flexibility under the current system, and as issuers and other
sellers of securities have found mechanisms to utilize exemptions
and jurisdictional limitations under the current system because
they find its requirements too burdensome, the core protections
of the current system have begun to erode.-[17]- By
contrast, with a rationalized, streamlined and cost effective
regulatory process in place, the incentive for issuers to utilize
jurisdictional or other means to escape the Securities Act should
be substantially diminished. Concomitantly, the opportunity is
presented to reinstate and provide for better investor
protections. At base, by reducing unnecessary costs of complying
with the registration requirements of the Securities Act, the
Committee expects that more issuers will register more offerings,
thereby extending the benefits of the Securities Act to more
investors.
Company registration also will further the longstanding
Commission goal of improving the quality and reliability of
information disseminated by public corporations on an ongoing
basis to a level comparable to that traditionally provided in
primary offerings.-[18]- Disclosure will be required on an
---------FOOTNOTES----------
-[17]- See p. 36-54 of Appendix A to the Report for more
detail.
-[18]- As Milton Cohen observed in 1985, "[d]isclosures
for [Exchange] Act purposes still tend to be taken
less seriously, and to be of lower quality, than
(continued...)
==========================================START OF PAGE 20======
Exchange Act Form 8-K of transactional information and material
developments at the time of virtually all equity offerings. This
requirement also will ensure full availability to investors of
Securities Act (as well as Rule 10b-5) remedies for material
deficiencies in that information, facilitate the due diligence
efforts of underwriters and other participants in the offering,
and provide material information regarding the issuer and the
transaction to the markets earlier than under the current system.
Reordering and rationalizing the various gatekeeping or
monitoring functions to provide greater oversight of the issuer's
disclosures on an ongoing basis will be accomplished through the
provision of more detailed and explicit guidance regarding the
due diligence and reasonable care defenses of certain gatekeepers
under Sections 11 and 12(a)(2) of the Securities Act. Such
guidance should encourage companies to adopt interim reviews of
financial information by outside auditors, a disclosure committee
of the board to perform continuous oversight of the disclosure
process, and various other measures.
In addition, the flexibility company registration provides
to issuers to tailor offering materials to the needs of
---------FOOTNOTES----------
-[18]-(...continued)
those historically provided, and still aspired to,
under the [Securities] Act despite the advent in
1982 of incorporation by reference of Exchange Act
reports into Securities Act registration
statements." Milton H. Cohen, The Integrated
Disclosure System -- Unfinished Business, 40 Bus.
Law. 987, 992 (1985).
==========================================START OF PAGE 21======
investors, including putting them in plain English, will result
in those documents being more readable and more informative, just
as "profile prospectuses" in the mutual fund industry are more
readable. Thus, company registration complements well, and
furthers, the potential application of the Commission's "plain
English" initiative.
The Committee recognizes that there may be costs associated
with an issuer's opting into the pilot, particularly in
connection with the adoption of the recommended disclosure
enhancements discussed below. In the Committee's view, however,
issuers should embrace both the mandatory and voluntary
disclosure enhancements because they reflect better practices,
should help reduce the potential for litigation based on material
misstatements or omissions, and will, in the long run, result in
lower costs to the issuer when it proceeds to market. Because
participation in a company registration system would be voluntary
during the pilot, companies would be free to make their own
judgments whether the benefits of more efficient and less costly
access to capital pursuant to the company registration system
outweigh any attendant costs.
B. Key Elements of the Recommendations
The following is a summary of the basic recommended features
of the company registration system and pilot, as well as the
Disclosure Committee proposal. A full description of the
specific elements of the pilot is provided in Appendix B and in
the Term Sheet.
==========================================START OF PAGE 22======
1. The Offering Process. The basic principle of a company
registration system is that the regulatory process is company-
based, rather than transaction-based. Once meeting eligibility
standards, companies would register with the Commission. To
become company-registered, an eligible company would file a Form
C-1 registration statement, much like the current process for
registering a class of securities under the Exchange Act, and
also disclose its plans to sell securities from time to time in
the indefinite future on a company-registered basis. Much like
today, companies also would file Exchange Act reports, which
would automatically be incorporated into the Form C-1, and the
information in the company's public file would then form the
primary basis for decisions by the investing public with respect
to a registered company's securities.
Only a nominal registration fee would be paid when the
company is first registered. The issuer would pay a full
registration fee at the time of sale based on the amount of
securities to be sold. In effect, this process would create a
"pay-as-you-go" system somewhat similar to that now available to
open-end investment companies registered under the Investment
Company Act of 1940.
Under a full company registration system, once a company is
registered and filing periodic and current reports, most routine
sales and resales of the company's securities would be
consummated immediately without any additional Commission staff
review prior to the sale of the security, just as is the case
==========================================START OF PAGE 23======
today for takedowns from a shelf, and would be based primarily
upon the information contained in the company's updated Exchange
Act disclosure file. All subsequent sales of covered securities
by registered companies and their affiliates (outside Rule 144)
would be deemed to be covered by the registration statement, and
thus would be registered for purposes of the Securities Act. All
purchasers of securities from the issuer or its affiliates,
regardless of the nature of the transaction, thus would receive
freely tradeable securities, as well as the benefit of all
statutory remedies that now attach to information disseminated in
connection with a registered offering of securities. Therefore,
investor protection would be enhanced and extended to a broader
class of transactions, while the need for concepts such as gun-
jumping and restricted securities would be eliminated.
At the time of each offering, the issuer would file with the
Commission material information relating to both the specific
offering, as well any material updates to the filed company-
related information that has not already been disclosed in its
filings at the time of the transaction. In the case of non-
convertible debt and de minimis equity offerings, that
information could be filed by the issuer with the Commission on a
Form 8-K or, a prospectus supplement, and the registration fee
for the specific offering would be paid. In the case of an
equity offering over a de minimis threshold (e.g., more than
three percent of the public float of the security in any three
business day period), this information must be filed on a Form 8-
==========================================START OF PAGE 24======
K, rather than merely in a prospectus supplement, on a date no
later than the date of the first sale. This Form 8-K
transactional filing, which is not required today for takedowns
from a shelf registration, will ensure that this important
information is incorporated into the registration statement and
thus within the coverage of Section 11 liability, and facilitate
the due diligence inquiries of underwriters and other
gatekeepers, thereby improving the quality of the disclosure made
to investors in both the primary and secondary trading markets.
The Committee also recommends that, during the pilot, this Form
8-K filing requirement be applied to all non-de minimis equity
offerings utilizing the current shelf registration process.
In further distinction to the current system, where a Form
8-K is required to be filed or is voluntarily filed for the
purposes of the incorporation by reference method of prospectus
delivery (as discussed more fully below), any information that is
material company-related disclosure (including, where necessary,
an updated Management's Discussion and Analysis) that is not yet
in the public file would be required to be filed some period of
time before the sale (which could be, for example, the same day
as, or one to three business days before, the transaction,
depending on the issuer and the information) to provide an
adequate opportunity for the market to absorb the information.
(The transactional information, however, normally need not be
filed until the day of sale.) The company registration system
thereby corrects a clear infirmity in the current system,
==========================================START OF PAGE 25======
especially where transactions with purchasers are priced on the
basis of the current market price of the issuer's securities.
The filing requirements regarding an auditor's consent to
the use of its report in connection with the issuer's financial
statements would remain unchanged from those followed today with
respect to primary shelf offerings.-[19]-
Thus, company registration would enhance the timeliness,
quality, and level of information about companies and their
offerings that currently is made available to investors and the
markets through Commission filings. At the same time, as noted
below, company registration would afford companies offering their
securities to the public the flexibility to tailor the disclosure
documents actually delivered to investors to the nature of the
transaction and the demands of the offering participants.
2. Prospectus Delivery Requirement. In routine offerings,
issuers would have greater flexibility with respect to the
delivery of both the company-related and transactional
information mandated in a public offering. This flexibility
regarding the delivery of information to investors is in contrast
to the filing of disclosure documents with the Commission: those
filed documents will be subject to the same Securities Act
content requirements but, in many instances, will be filed on an
accelerated basis. Rather than imposing formal, full-fledged
delivery requirements in connection with all issuances of
---------FOOTNOTES----------
-[19]- See p. 24-28 of Appendix B to the Report.
==========================================START OF PAGE 26======
securities to the public, the appropriate style and level of
company and transactional disclosure that physically would be
delivered to investors would be determined in most offerings by
considerations relating to informational demands of participants
in the particular offering, thereby facilitating more useful and
more readable ("plain English") disclosure.
Specifically, in routine offerings under company
registration, where physical delivery of a traditional prospectus
would not be mandated because the requisite information has been
filed on a Form 8-K and may be incorporated by reference and
constructively delivered, issuers and underwriters would be free
to decide whether to use some form of a formal prospectus and
what information to disclose in that prospectus if
used.-[20]- The Committee expects that the information
that actually is delivered to investors in the form of a term
sheet, selling materials or a more formal prospectus, would be
the information that the issuer deems most relevant and material
to the investment decision. Because all mandated company and
transactional disclosure must be filed with the Commission and
made part of the registration statement, strict liability will
attach to this information. To the extent an issuer elects to
---------FOOTNOTES----------
-[20]- Just as under the current system, to the extent
that disclosure made in any delivered document
might be rendered misleading by the omission of
information contained only in documents filed with
the Commission, such as the transactional Form 8-
K, the delivered documents must include such
information. See p. 17-18 to Appendix B of the
Report.
==========================================START OF PAGE 27======
use selling material without delivering a statutory prospectus,
those materials that ordinarily would not be filed at all and
would have only Rule 10b-5 liability, will now be filed and have
Section 12(a)(2) liability. As is the case with the takedown
prospectus supplement under today's shelf procedures, there would
be no prior Commission staff review of any disclosure document
prior to the sale of the securities (although the Commission
staff may choose to review such a document, as it might any
other, in conjunction with a review of the company's disclosure
file).-[21]-
In those circumstances where the company registration system
would continue to mandate formal prospectus delivery, physical
delivery of the formal prospectus must be provided to non-
accredited investors in sufficient time to influence the
investment decision.-[22]- This is in sharp contrast to
the current system, where, as noted above, the disclosure
---------FOOTNOTES----------
-[21]- Even in the absence of Commission staff review at
the time of the offering, issuers and underwriters
still must comply with all other applicable
regulatory requirements, e.g., state Blue Sky
requirements, exchange and Nasdaq listing
requirements, and NASD review of underwriter
compensation.
-[22]- In these non-routine equity transactions, the
prospectus received by the non-accredited
investors prior to the sale would be similar to
the preliminary prospectus mandated in initial
public offerings (cf. Rule 15c2-8 under the
Exchange Act [17 CFR 240.15c2-8]) and also
routinely disseminated in non-shelf repeat equity
offerings where the price-related and other
current information often would not be
incorporated into the document prior to sale.
==========================================START OF PAGE 28======
document frequently is received by investors at the time of the
confirmation of sale -- often days after the investment decision
has been made.
For purposes of the pilot, the different levels of
transactions requiring varying levels of prospectus delivery
essentially fall into three tiers. The Commission may wish to
consider whether the second tier (Nonroutine Transactions) is
necessary and whether it is practicable to require delivery of
prospectus information prior to the sale, or whether the system
could be simplified by extending the procedure for Routine
Transactions to this second tier.
o Routine Transactions (e.g., all offerings of all
covered securities, except offerings of voting equity
amounting to 20% or more of the existing public float
of the security;-[23]- similar limitations on
"routine" issuances for other types of securities could
possibly be adopted as well)(This category established
for prospectus delivery purposes encompasses the de
minimis equity and other types of offerings that are
exempt from the mandatory Form 8-K filing requirement.)
The issuer could continue to use traditional
prospectus delivery.
In the alternative, the issuer may incorporate by
reference any publicly filed information into a
document serving as the prospectus, such as the
confirmation of sale or selling materials.
Issuers would file transactional and updating
disclosure with the Commission on a Form 8-K and
incorporate this information as well as any other
---------FOOTNOTES----------
-[23]- Based on data from 1992-1994, approximately 70% of
all firm commitment common equity offerings would
be deemed routine under this threshold. See Figure
6 in the Addendum to Appendix A of the Report.
==========================================START OF PAGE 29======
necessary information in other filed
reports.-[24]- Much like under shelf
registration today, the disclosure incorporated by
reference need not be repeated in the document
serving as the prospectus. All mandated
disclosure, including transactional disclosure,
may be incorporated by reference from Exchange Act
reports, a more flexible standard than under the
current shelf registration system where
transactional disclosure may not be incorporated
by reference and must actually be delivered
(albeit frequently after the investment decision
has already been made).
If the issuer wishes to use selling materials
without having delivered a formal prospectus, the
issuer would simply incorporate by reference into
those selling materials the transactional
disclosure and any material company-related
updating disclosure (i.e., the disclosure
currently required under shelf registration to be
delivered in a formal prospectus) as well as all
of the Exchange Act reports on file. The selling
materials then would be treated as the statutory
prospectus, including for liability purposes.
This new flexibility to use abbreviated selling
materials without incurring the obligation to
deliver physically a full statutory prospectus
will facilitate the development of summary
prospectuses and plain-English disclosure
documents.
o Non-routine Transactions (e.g., offerings of voting
equity amounting to 20% or more of existing public
float of the security)
The current requirement under shelf registration
that transactional information (and any material
updating company disclosure not already on file
with the Commission) actually be delivered to
investors in a formal prospectus (as opposed to
incorporated by reference from filed documents)
would be retained. Where this more traditional
---------FOOTNOTES----------
-[24]- With respect to the filing requirement, unless the
transaction is de minimis, the Form 8-K would be
required to be on file in any equity offering
regardless of whether the information is
incorporated into a document serving as a
prospectus.
==========================================START OF PAGE 30======
prospectus is mandated to be delivered to the
investor, delivery should be required to be made
to investors prior to sale.
ø Traditional prospectus delivery may be useful
in transactions that would alter
significantly the information previously
disseminated to the markets and that likely
would be accompanied by significant selling
efforts.
Physical delivery of a prospectus would not be
required for accredited investor purchasers.
o Extraordinary Transactions (securities transactions
that fundamentally change the nature of the company
(e.g., offerings of voting equity amounting to 40% or
more of the existing public float of the security))
Traditional prospectus delivery would be mandated
as in non-routine transactions.
The opportunity for Commission review of the
prospectus prior to its use would be retained for
this category of transactions.
Physical delivery of a prospectus would not be
required for accredited investor purchasers.
==========================================START OF PAGE 31======
COMPANY REGISTRATION PILOT
SIZE/TYPE OFFERING
----------------------------------------------Equity--------------------------------| Non-convertible Debt
De Minimis Routine Non-routine Extraordinary
<=3% >3% <20% >=20% <40% >=40%
Transactional Optional Yes Yes Optional
8-K -[1]- Yes
Filing
required (at
or prior to
sale)
No (unless No (unless No (unless No (unless
Post- fundamental fundamental fundamental Yes fundamental
effective change to change to change to change to
Amendment -[2]- R/S) R/S) R/S) R/S)
(must be
declared
effective by
staff before (1) (1) Traditional Traditional No (if
takedown) Traditional Traditional prospectus prospectus choose to be
prospectus prospectus supp. supp. covered,
Prospectus supp. supp. delivered to delivered to treat as
Delivery -[2]- delivered at delivered at investor investor Routine
or prior to or prior to prior to prior to regardless
confirm; or confirm; or confirm and confirm and of face
(2) (2) at same time at same time amount of
Transactional Transactional filed with filed with offering)
SEC under SEC under
information information cover of 8-K. cover of 8-K.
filed on filed on
Form 8-K and Form 8-K and Incorporation Incorporation
incorporated incorporated by by
by reference by reference reference reference
3 into 3 into option option
confirm or confirm or available available
sales sales only with only with
literature, literature, respect to respect to
which is which is accredited accredited
then then investors investors
delivered as delivered as
statutory statutory
prospectus prospectus
at or prior at or prior
to confirm to confirm
-[1]- All equity and equity equivalents.
-[2]- Voting equity or equivalents only.
-[3]- Where disclosable (e.g., per 10b-5 (Basic) and/or 8-K
line item) material change regarding company has
occurred since last 10-K, 10-Q or 8-K and using
incorporation by reference method of prospectus
delivery, must file 8-K reporting change in sufficient
time before takedown to permit market assimilation
(e.g., 1 to 3 days).
==========================================START OF PAGE 32======
3. Scope. Participation in the company registration pilot
would be voluntary and would be limited to a senior class of
seasoned issuers, i.e., issuers with a $75 million public float,
two years of reporting history, and a class of securities listed
on a national securities exchange or traded on the National
Market System of the Nasdaq Stock Market. Thus, the current
Securities Act transactional system, including specifically,
where applicable, Commission staff review of transactional
documents prior to the offering, would be retained for all other
issuers including for those engaging in initial public offerings.
Foreign issuers could participate if they adopt the
reporting requirements applicable to domestic companies and
otherwise meet the eligibility criteria, including adopting the
disclosure enhancements described below. The Committee
recommends, however, that the Commission consider whether
accommodations should be made for foreign issuers similar to
those that permit such issuers to use the shelf today.
The extent to which smaller, less seasoned companies could
benefit from the system will depend on experience with the pilot
and, if otherwise deemed appropriate based on such experience,
may require mandating such additional protections as traditional
prospectus delivery, greater advance notice for prospective
investors of company and transaction information before any
offering, or the retention of the potential for staff review of
==========================================START OF PAGE 33======
annual financial information before its use in connection with an
offering.
A company may opt out of the pilot by withdrawing its Form
C-1, but would not be eligible to opt back into the company
registration system for a period of two years. For purposes of
the pilot, noncompliance with the issuer eligibility conditions
or any of the mandatory disclosure enhancements in any material
respect would result in the loss of eligibility to make offerings
pursuant to the Form C-1 for a two-year period. Moreover, an
issuer would have to be current in its reporting obligations at
the time of each offering.
Under full company registration, all issuances of any
covered security by a registered company or its affiliates,
including those issuances made for acquisitions, would be
afforded the same legal status and carry the same protections as
securities registered under the Securities Act today.
Accordingly, all securities sold by a registered company would be
freely tradeable. Thus, a principal benefit of the comprehensive
nature of company registration is that distinctions currently
existing between public and nonpublic offerings (with the
resultant formalities and restrictive concepts such as gun-
jumping and integration) would be eliminated. For example,
securities sold overseas by a registered company would be deemed
registered to the extent of any flowback of those securities into
the United States, providing investors in the United States the
==========================================START OF PAGE 34======
same protections they would have had if the securities had been
sold initially in this country.
In addition, by thus eliminating the risk of unregistered
distributions through the use of conduits, the system also
eliminates any need for restrictions on resales by affiliates and
statutory underwriters. Consequently, only the Chief Executive
Officer and inside directors, as well as holders of 20% of the
voting power, or 10% of the voting power with at least one
director representative on the board, need be subject to
affiliate resale restrictions. Similarly, the statutory
underwriter concept would apply only to persons engaged in the
business of a broker-dealer (whether or not so registered) who
participate in a distribution of securities by a registered
company or its affiliates under the Form C-1.
At their option, under the pilot, participating companies
may elect to continue to conduct offerings not registered under
the Securities Act (such as private placements and other
transactional exemptions, and offshore offerings under Regulation
S) for all types of securities, i.e., "modified company
registration." Although the Committee was aware that the
addition of a modified company registration option would add
complexity, the Committee was concerned that, at this initial
stage and until issuers become comfortable with the company
registration concept, the loss of the ability to conduct exempt
private placement and offshore offerings could be a deterrent to
==========================================START OF PAGE 35======
the voluntary use of the company registration system.-[25]-
Therefore, to permit a meaningful test of the company
registration concepts during the pilot stage, the Committee
believes that issuers should be afforded the option of continuing
to conduct nonregistered offerings, while still availing
themselves of most of the benefits of the system. Companies
could choose either to waive transactional exemptions, or
determine to preserve the option to exclude those transactions
from the company registration system by using the modified
version of this system. Under either approach, however,
companies could choose to exclude straight debt securities. If a
company chooses to conduct an exempt offering, the securities
issued outside the Form C-1 would remain subject to the current
concepts of restricted securities, and the resale restrictions
and registration requirements applicable to current affiliates
and statutory underwriters would remain. Exempt offerings,
however, would not be subject to integration with offerings made
pursuant to the company registration statement.
The benefits resulting from registration, including the
issuance of freely tradeable securities in what otherwise would
have been a private transaction resulting in restricted
securities, should outweigh any additional costs imposed by
registering the securities under the system. Illiquidity
---------FOOTNOTES----------
-[25]- Transcript of May 8, 1995 Advisory Committee
Meeting at 177 (statements of Professor Coffee).
==========================================START OF PAGE 36======
discounts typically imposed by the market on non-registered
securities should be eliminated for all securities issued under
the company registration system. As noted, these discounts can
range up to 20 percent for equity, compared to 0 basis points
market discount for shelf registered equity offerings (5 percent
total underwriter spread and fees).-[26]- Also, issuers
would ultimately benefit by the reduction or elimination of the
costs and uncertainties that today result from complex
interpretive concepts and the concomitant need to monitor
transactions in restricted securities.
4. Disclosure Enhancements. In the Committee's view,
enhancing the quality and reliability of secondary market reports
is an integral part of an effective company registration system,
because these reports are the cornerstone of the offering
disclosures by company-registered issuers. While the Committee
does not consider the quality and reliability of the current
secondary market disclosure system to be so deficient as to
compromise investor protection, the Committee does find that
there is room for improvement.-[27]- With registered
companies having almost immediate access to the capital markets,
new measures are necessary and appropriate to provide assurance
regarding the integrity of the disclosure disseminated by those
companies on an ongoing basis. For these reasons, the Committee
---------FOOTNOTES----------
-[26]- See p. 37 and Table 1 of Appendix A to the Report.
-[27]- See p. 45-49 of Appendix A to the Report.
==========================================START OF PAGE 37======
believes that secondary market disclosures must be improved and
enhanced.
The Committee recommends that any company registration
system adopted by the Commission include a series of procedural
disclosure enhancements as part of opting into company
registration and remaining in the system. The purpose of these
disclosure enhancements is to ensure that those individuals and
entities best equipped to guard the integrity of the disclosure
provided in the company's filed reports focus increased attention
on these disclosures:
Top Management Certifications Certification to the
Commission (not a filed document) would be required of
two of any of the following four officers, attesting
that they have reviewed the Form 10-K, the Form 10-Qs
and any Form 8-Ks reporting mandated events, but not
for voluntarily filed Form 8-Ks, and that they are not
aware of any misleading disclosures or omissions: the
chief executive officer, chief operating officer, chief
financial officer, or chief accounting officer. The
attestation would be required upon the filing of each
such document with the Commission.
Management Report to Audit Committee A report
prepared by management and addressed and submitted to
the board of directors' audit committee (or its
equivalent or the disclosure committee, if adopted and
different from the audit committee) describing
procedures followed to ensure the integrity of periodic
and current reports and procedures instituted to avoid
potential insider trading abuses (e.g., any requirement
that company insiders clear trades with the issuer's
general counsel).-[28]- This report would be
---------FOOTNOTES----------
-[28]- The recommendation that the Report cover
procedures to prevent insider trading was
suggested to complement the elimination of Form
144 filings by those affiliates (officers and
directors) who no longer would be subject to
resale restrictions. Those filings were believed
to serve as a mechanism to help police improper
insider trading.
==========================================START OF PAGE 38======
made public as an exhibit to the Form 10-K; the report
need not be resubmitted on a yearly basis if the
described procedures are unchanged.
Form 8-K Enhancements Expansion of current reporting
obligations on Form 8-K under the Exchange Act to
mandate disclosure of additional material developments:
ø Material modifications to the rights of
security holders (current Item 2 of Form 10-
Q);
ø Resignation or removal of any of the top five
executive officers;
ø Defaults of senior securities (current Item 3
of Form 10-Q);
ø Sales of a significant percentage of the
company's outstanding stock (whether in the
form of common shares or convertible
securities or equity equivalents);
ø Issuer advised by independent auditor that
reliance on audit report included in previous
filings is no longer permissible because of
auditor concerns over its report, or issuer
seeks to have a different auditor reaudit a
period covered by a filed audit report.
For the above items that are required now to be filed
on a Form 10-Q, the information therefore would be
provided on a current, rather than a quarterly, basis.
Moreover, the period within which a Form 8-K must be
filed following any mandatory event specified in that
form would be accelerated from 15 calendar days to 5
business days.
Risk Factors Risk factor analysis disclosure
requirements to the extent currently required in an
issuer's Securities Act filings would be added to the
Form 10-K.
Voluntary Measures Voluntary measures would be
encouraged by the opportunity for various gatekeepers
to make the due diligence process more efficient, and
would consist of: auditor review of interim financial
information either consistent with SAS No. 71 or a more
detailed interim audit procedure; auditor review of
events subsequent to the date of the audited financial
statements that may bear materially on those statements
==========================================START OF PAGE 39======
pursuant to SAS No. 37; opinion letters by auditors
pursuant to SAS No. 72 and by issuer's counsel that are
provided to underwriters and outside directors in
connection with offerings; and the establishment of a
"disclosure committee" of outside directors (which
could be the existing audit committee).
5. Liability While the Committee evaluated alternative
liability schemes in its consideration of the company
registration system, the Committee has determined that the
company registration model should maintain the current Securities
Act liability scheme at least during the pilot stage. The
Committee believes that the continued application of the current
liability scheme will ensure the maintenance of familiar investor
protection concepts during the transition from a transactional-
based system to a company-based system.
In fact, investor protection would be enhanced under the
pilot program. Notably, under the current shelf system,
companies deliver transactional information in a traditional
prospectus supplement that, although filed with the Commission,
is not deemed filed as part of the registration statement. As a
consequence, investors are denied the core protections of Section
11 of the Securities Act with respect to this
information.-[29]- By contrast, the pilot would expand the
scope of the Section 11 protections to these disclosures through
its requirement of a Form 8-K filing for non-de minimis equity
---------FOOTNOTES----------
-[29]- See Elimination of Pricing Amendments and Revision
of Prospectus Filing Procedures, Securities Act
Rel. 6672 ( Oct. 27, 1986)[51 FR 39868 (November
3, 1986)].
==========================================START OF PAGE 40======
offerings. For companies that fully opt into the system,
liability also would be expanded to cover transactions that are
not now subject to Section 11 liability, such as the flowback of
overseas offerings, private placements and other transactions
currently deemed "exempt" offerings. In addition, sales
literature that today only receives the protection of Rule 10b-5
would, under many circumstances, receive the enhanced protection
of Section 12(a)(2) of the Securities Act.
6. Due Diligence In reaching its conclusion to retain
the current Securities Act liability structure, the Committee
weighed concerns regarding the due diligence responsibilities of
various gatekeepers stemming from the expedited nature of the
current shelf registration process, and recognized that company
registration could further expedite the offering process.
Although the current system expects outside parties to act as
gatekeepers in the offering process, in practice and for a
variety of reasons, such roles are not necessarily being
fulfilled in the manner anticipated when the Securities Act was
adopted.-[30]- From the outset, the Committee sought to
buttress and strengthen the gatekeepers' roles in protecting
investors not only in the context of episodic, transaction-
specific oversight, but also, and with increased emphasis, in the
context of ongoing oversight by those persons in the best
---------FOOTNOTES----------
-[30]- See ABA Committee on Federal Regulation of
Securities, Report of Task Force on Sellers' Due
Diligence and Similar Defenses Under the Federal
Securities Laws, 48 Bus. Law. 1185 (May 1993).
==========================================START OF PAGE 41======
position to monitor the integrity and accuracy of company
disclosures. Separately, proponents of the proposed Form 8-K
filing requirement at the time of the transaction asserted that
such a filing would help serve to focus and facilitate the due
diligence inquiries of underwriters.
As part of the adoption of company registration, the
Committee recommends that the Commission provide interpretive
guidance to gatekeepers as to more effective methods of
satisfying the "reasonable investigation" and "reasonable care"
standards, respectively, of Sections 11 and 12(a)(2) of the
Securities Act. In this regard, the Committee recommends
expanding the factors (currently enumerated in Securities Act
Rule 176) that may be taken into account by gatekeepers or
monitors in determining their appropriate due diligence
investigation, to refer specifically to compliance with the
mandatory and voluntary procedures outlined in the disclosure
enhancements. To the extent that the addition of disclosure
enhancements, including voluntary enhancements such as SAS No. 71
reviews by independent auditors, increases the attention paid to
the disclosure by those having the best opportunity to monitor
the issuer on an ongoing basis, other participants in the
gatekeeping process could take such efforts into account when
deciding the appropriate level of due diligence needed to be
performed in order to satisfy their own statutory duties, and in
determining how best to satisfy those duties.
==========================================START OF PAGE 42======
The underwriter thus would continue its pivotal role in
ensuring the adequacy of disclosure at the time of the offering
by drawing upon all available sources of information concerning
the company and assessing the scope of the ongoing reviews
conducted by the other gatekeepers in evaluating the appropriate
due diligence the underwriters should perform. In this fashion,
the Committee has recognized both the practical demands of market
participants and the need to maintain the integrity of the
disclosure system. If the proposals to enhance and rationalize
the due diligence process on an ongoing basis are implemented,
the gatekeeping function ultimately should be more effective in
protecting investors and in ensuring the integrity of corporate
disclosure disseminated to the markets, not only in the context
of episodic public offerings, but with respect to continuous
secondary market trading as well. This principle is consistent
with one of the primary motivating factors underlying a shift
towards a company registration model: namely, the tremendous
movement during the last few decades in investor transactions
from the primary issuance markets to the secondary trading
markets. Since only four to six percent of exchange and Nasdaq
traded issuers make public offerings of equity in a given
year,-[31]- strengthening the gatekeeping function
available on a continuous basis provides greatly enhanced
protection to investors overall.
---------FOOTNOTES----------
-[31]- See Figure 4 in the Addendum to Appendix A of the
Report.
==========================================START OF PAGE 43======
The Committee also urges the Commission to continue
exploring means to make the current liability structure more
effective and more fair for gatekeepers in light of modern
offering practices and techniques. After the Commission gains
experience with the company registration offering process under
the pilot, the Committee recommends that the Commission revisit
the possibility (and the advisability) of providing more concrete
guidance to various gatekeepers as to when they may be deemed to
have satisfied their respective due diligence obligations.
7. Disclosure Committee
In the course of its deliberations on the company
registration model, the Committee considered a separate proposal
to expand the role of the outside directors in ensuring the
integrity of corporate disclosures.-[32]- Although not a
necessary part of the company registration model developed by the
Committee, the Committee strongly recommends that the Commission
endorse (but not require) a new procedure whereby outside
directors use the issuer's audit committee (or a separate
---------FOOTNOTES----------
-[32]- According to Professor Coffee, this concept would
incorporate "the traditional reliance defense
under state corporation law. Under such a rule,
other outside directors could rely on a committee
of directors --- tentatively called the
'disclosure committee' -- which would review the
company's interim [Exchange] Act filings, such as
its Form 10-K and Form 10-Q's, and consider the
need for additional disclosures to cover material
developments." John C. Coffee, Jr., An
'Evergreen' Company Registration Approach Would
Modernize the 1933 Act, Nat'l L. J., Sept. 11,
1995, at B4.
==========================================START OF PAGE 44======
committee of one or more outside directors to be known as a
"disclosure committee") to conduct an investigation of the
issuer's disclosures. The Committee believes that this proposal
has merit whether or not company registration is pursued by the
Commission.
The disclosure committee could conduct this investigation,
just as a board of directors may appoint a committee to engage in
other types of specialized inquiries, so long as (a) the
delegating directors reasonably believe that the member(s) of the
disclosure committee are sufficiently knowledgeable and capable
of discharging due diligence obligations on behalf of the outside
directors (if necessary, with the assistance of their
professional advisers) and are provided with adequate resources
to conduct the requisite investigation -- that is, the delegation
must be reasonable; (b) the delegating directors maintain
appropriate oversight of the disclosure committee (which would
entail requiring the disclosure committee to report periodically
to the Board on the procedures followed to ensure the integrity
of the disclosure) and reasonably believe that the disclosure
committee's procedures are adequate and were being performed; and
(c) the delegating directors reasonably believe that the
disclosure is not materially false or misleading.
Although the reasonableness of a delegating director's
reliance on the disclosure committee, as well as the director's
belief in the accuracy of the disclosure based solely upon the
establishment of and procedures for investigation by the
==========================================START OF PAGE 45======
disclosure committee, will depend on the facts and circumstances
of each offering, the Committee believes that this practice
generally will permit a delegating director to satisfy its
obligations under both federal and state law.-[33]- In
addressing the liability of outside directors under Section 11,
the legislative history to the Securities Act states that
"reliance by the fiduciary, if his reliance is reasonable in the
light of all the circumstances, is a full discharge of his
responsibilities."-[34]- The requirements that the
delegation be reasonable and that the committee members
---------FOOTNOTES----------
-[33]- Under state law, where each director has a
fiduciary duty with respect to the corporation,
directors may create committees to ensure the
proper functioning and discharge of their
fiduciary obligations. See, e.g., 8 Del. C.
141(e) (Del. 1994); 15 Pa.C.S.A. 1712(a)(3)
(Penn. 1995); American Law Institute, Principles
of Corporate Governance 4.03 (1994). The
legislative history of Section 11 of the
Securities Act, including the 1934 amendment to
the Act which deleted the original fiduciary
standard and substituted a "prudent man" standard,
does not suggest that Congress intended a more
strict standard to apply under federal law. H.R.
Rep. No. 1838, 73d Cong., 2nd Sess. 41 (1934). See
James M. Landis, The Legislative History of the
Securities Act of 1933, 28 Geo. Wash. L. Rev. 29,
47-48 (1959) (stating the drafter's belief that "a
goodly measure of delegation was justifiable,
particularly insofar as corporate directors are
concerned").
-[34]- H.R. No. 152, 73d Cong., 1st Sess. at 26 (1933).
See also Circumstances Affecting the Determination
of What Constitutes Reasonable Investigation and
Reasonable Grounds for Belief Under Section 11 of
the Securities Act; Treatment of Information
Incorporated by Reference Into Registration
Statements, Securities Act Rel. 6335 (August 6,
1981) n. 106 [46 FR at 42022 (August 18, 1981)].
==========================================START OF PAGE 46======
periodically report on the procedures followed in conducting the
investigation,-[35]- should result in more meaningful
oversight of the issuer's disclosures by its outside directors.
The creation of such a voluntary committee would be consistent
with current corporate governance trends emphasizing the need for
outside directors to exercise continual diligence in monitoring
the performance of management and ensuring the candor and
completeness of company disclosures to the
marketplace.-[36]- Moreover, the Commission recently
underscored the critical role of corporate directors in
---------FOOTNOTES----------
-[35]- Cf. The Obligations of Underwriters, Brokers and
Dealers in Distributing and Trading Securities
Particularly of New High Risk Ventures, Securities
Act Rel. No. 5275 (July 26, 1972) [37 FR 16011
(Aug. 19, 1972)] at text accompanying n. 29
(discussing relative responsibilities of the
managing versus participating underwriters: "Thus,
although the participant may delegate the
performance of the investigation, he must take
some steps to assure the accuracy of the
statements in the registration statement. To do
this, he at least should assure himself that the
manager made a reasonable investigation").
-[36]- See, e.g., J. Lorsch, Empowering the Board, Harv.
Bus. Rev., Jan.-Feb. 1995, at 107, 113 ("[a]udit
committees made up of outside directors in all
public companies ensure that financial reports are
accurate, that accounting rules are followed, and
that assets are not misappropriated"); F. Lippman,
What Should the Audit Committee Do? 3 Corp. Gov.
Adv. 22 (March/April 1995); I. Millstein, The
Evolution of the Certifying Board, 48 Bus. Law.
1485 (1993).
==========================================START OF PAGE 47======
safeguarding the accuracy and integrity of a registrant's
periodic reports and other public statements.-[37]-
This governance mechanism would benefit investors in a
variety of ways. First, it would ensure more continuous
oversight of the disclosure preparation process and, over time,
improve the quality and integrity of periodic and secondary
market reporting and disclosure generally. Second, it will
provide a focus at the board level for due diligence in the
context of primary offerings by issuers, thereby ensuring greater
involvement by outside directors as one set of monitors. Third,
it will provide a practical means for greater outside director
involvement with the due diligence activities of other
gatekeepers, such as underwriters.
Thus, the Committee hopes that many registered companies --
regardless of whether they are permitted to or elect to
participate in the company registration system -- would choose to
implement this measure as a natural extension of present "best
practices" that promote investor confidence in the adequacy of
corporate disclosures. The result would be an increased focus by
the board on its existing statutory obligations, and additional
---------FOOTNOTES----------
-[37]- See Report of Investigation in the Matter of the
Cooper Companies, Inc. as it Relates to the
Conduct of Cooper's Board of Directors, Exchange
Act Rel. 35082 (December 12, 1994). See also
Report of Investigation in the Matter of National
Telephone Co., Inc. Relating to Activities of the
Outside Directors, Exchange Act Rel. 14380
(January 16, 1978).
==========================================START OF PAGE 48======
review by a qualified committee-[38]- of outside directors,
while allowing the outside directors an appropriate mechanism to
fulfill their Securities Act responsibilities.
III. CONCLUSION
The Committee believes that company registration is superior
to incremental liberalization of the current offering process.
Short of implementing company registration, the Commission could
continue its approach of implementing incremental changes to
improve seasoned issuer access to the markets, particularly
through further liberalization of the shelf procedure. As noted
in the description of the offering process under the company
registration model, much of the suggested company registration
pilot can be implemented primarily by modifying and liberalizing
the shelf concept. Similarly, the Commission could take discrete
steps to allow issuers to meet market demands within the
framework of the current registration scheme, such as the
elimination of the nonfungibility requirement of Rule 144A, the
broadening of the eligibility requirements for purchasers in the
Rule 144A market, the minimization of the resale limitations on
restricted securities, the allowance of greater flexibility under
the gun-jumping doctrine to permit "testing of the waters," and
---------FOOTNOTES----------
-[38]- Establishment of disclosure committees might also
lead to the appointment of disclosure specialists
(such as lawyers, accountants or bankers) to the
board so that they may serve as members of the
disclosure committee, just as directors are often
selected based upon their qualifications to serve
on audit committees.
==========================================START OF PAGE 49======
the implementation of more flexible regulatory interpretations
such as those permitting A/B exchange offers.
Indeed, the Committee is pleased that, since the time the
Committee began its deliberations and commenced its observations
on the shortcomings of the current system, the Commission has
made significant proposals, and the staff has rendered
interpretations, to begin to take some of these steps. The
Commission's Task Force on Disclosure Simplification followed the
work of the Committee and has recommended the measures crafted by
the Committee to streamline further the shelf offering
process.-[39]- The Task Force, however, did not make any
specific recommendations for Securities Act disclosure
enhancements or other measures to ensure adequate investor
protections in the context of a streamlined offering process;
instead it urges the Commission in implementing the streamlining
recommendations to take the steps necessary to ensure quality
disclosure and investor protection and points to the Committee's
efforts in that regard.-[40]-
---------FOOTNOTES----------
-[39]- Report of the Task Force on Disclosure
Simplification to the Securities and Exchange
Commission (March 5, 1996), at 34, 38-40 (the
"Task Force Report").
-[40]- As noted in the Task Force Report:
The recommendations for seasoned issuers set forth
under the [Task Force Report's] "Shelf Offerings"
caption, as well as certain other items in this Report,
are substantially identical to the streamlining
concepts of the "company registration" framework
developed by the Advisory Committee. Although the Task
Force was not designed to overlap with the work of the
(continued...)
==========================================START OF PAGE 50======
Nevertheless, continued incremental liberalization of the
offering process alone would not achieve all of the benefits
sought by the Committee. While such steps would benefit issuers
(including those who by choice or by reason of ineligibility
remain outside the company registration system), such steps
---------FOOTNOTES----------
-[40]-(...continued)
Advisory Committee, the Task Force members have
followed the work of the . . . Committee. The Task
Force recommends almost all of the streamlining
elements of company registration [e.g., eliminate
restrictions on at-the-market offerings, permit an
issuer to add additional securities without having to
file a new registration statement, narrow the
definition of affiliate, allow prospectus delivery by
means of full incorporation by reference into a
confirmation, and establish a pay-as-you-go fee
system]. Given its original purpose, the Task Force
only has sought to identify and recommend ways to
streamline the regulatory process and thus only has
looked at the suggestions individually. Were the
Commission to reach the next step of putting the pieces
together into a comprehensive package, the Task Force
recommends that the Commission consider reasonably
expected investor protections consequences of any
particular package. The Task Force notes that the
Advisory Committee has devoted significant time to
deliberations on these issues as it assembled its
complete [company registration] model and has added,
what the Advisory Committee intends to be, significant
investor protections.
* * * * *
The Task Force believes that the Commission, in its
consideration of these recommendations [to streamline
the existing shelf offering process] and any
alternatives that may be suggested, should take steps
to ensure that the quality of disclosure provided to
investors be at least of the same quality as that
provided to investors today. The Task Force notes that
improving the quality of disclosures in periodic
reports is an area being considered by the Advisory
Committee.
Id. at 34.
==========================================START OF PAGE 51======
should be balanced with increased protections for investors.
Moreover, as noted in this Report, there are investor protection
concerns in the current system that should be addressed before
further streamlining proceeds. In addition, without a shift in
the underlying regulatory philosophy, new "metaphysics" would
continually be constructed to preserve the Securities Act's
current transactional registration requirement. In the
Committee's view, these concepts and requirements will continue
to cause confusion, add substantial costs to the capital
formation process, and drive issuers to alternative markets where
investors will not be able to avail themselves of the protections
of the Securities Act.
The Committee believes that the cumulative effect of the
evolutionary changes in the markets since the 1930s now requires
a reassessment of the conceptual underpinnings of the regulatory
process, as opposed to continued incremental changes. Company
registration is consistent with the evolutionary approach of
incremental liberalization, but it is also, unmistakably, a new
departure. Unlike incrementalism, it says with finality that
registration should not take precedence over periodic disclosure
for companies that are already traded. It recognizes and
addresses what was not yet apparent in the early 1930s: the
economic importance of traded companies raising additional
capital by issuing securities. Thus company registration is far
more than a cost-reduction and efficiency reform. It is a new
beginning for the registration process, and it is overdue. The
==========================================START OF PAGE 52======
shift to a company registration system thus would change the way
we think about the regulation of the capital formation process
and foster a fresh approach to addressing the various problems.
This more comprehensive conceptual approach would address both
the interests of seasoned issuers in today's fast-moving markets,
and the implications of those changes in the markets and offering
processes for investors, underwriters, and other participants.
The company registration pilot described in this Report
continues the process of using the Commission's existing
rulemaking authority to effect appropriate reforms, rather than
recommending major legislative changes. The Committee decided at
the outset, at the urging of Chairman Levitt and Commissioner
Wallman, to promote primarily those modifications that could be
accomplished, at least initially, through rulemaking as opposed
to legislation. The benefit of this approach is that it provides
greater flexibility for Commission experimentation and timely
regulatory adjustments as dictated by experience with the pilot.
While some of the complexity and various aspects of the pilot are
necessary in order to fit within the current regulatory scheme
and would be unnecessary under a legislatively implemented
system, experience gained under the pilot will provide a firm
foundation for determining what legislative changes and/or
rulemaking changes, if any, would be appropriate to simplify
further the regulatory process and complete the long-awaited
transition to a company registration system.
==========================================START OF PAGE 53======
IV. SEPARATE STATEMENT OF JOHN C. COFFEE, JR.,
EDWARD F. GREENE, AND LAWRENCE W. SONSINI
We write separately, not to criticize the Advisory
Committee's Report (with which we fully concur), but to voice our
concerns that additional steps must be taken by the SEC to fully
realize the Report's goals and to stress the need for any
specific reforms adopted based on this Report to be consistent
with the integrated approach taken by this Report, which seeks to
pursue both deregulation and qualitative improvement in our
disclosure system. Achieving one without the other will not be
an advance. Essentially, we advance two basic contentions:
(1) The transition from the transaction-oriented disclosure
system of the past to the company registration system
envisioned herein must be accompanied by a corresponding
transition in liability rules. Otherwise, there is a
fundamental incongruence between what can realistically be
expected of the independent "gatekeepers" (outside
directors, accountants, underwriters and others) who monitor
the corporation's disclosures and their statutory
responsibilities under the Securities Act of 1933. In
particular, we are skeptical that practitioners will
recommend, or that corporations will adopt, some of the
reforms that this Report proposes (such as, in particular,
the disclosure committee) without further guidance from the
Commission. In particular, some form of safe harbor must be
developed that protects disinterested persons who undertake
==========================================START OF PAGE 54======
due diligence efforts under company registration from
thereby effectively incurring insurer-like liability for the
accuracy of all factual information incorporated into the
registration statement.
(2) The incentives to opt into a company registration
system are uncertain and limited. Some companies may prefer
to rely on the existing shelf registration system. In our
judgment, it is unwise to have two parallel systems, one
carrying the obligation to file a mandatory Form 8-K at the
time of a substantial equity issuance plus requirements for
certification by top management and the preparation of a
senior management report; and the other, not. Any disparity
between company registration and shelf registration that
requires mandatory filings, certifications, and reports
under the former (but not the latter) will create an
unfortunate and powerful incentive for issuers to opt to
remain within the existing shelf registration system. Thus,
we would urge the Commission to adopt similar requirements
with respect to the existing shelf registration system.
More generally, our concern is that pressures may develop
for the Commission to adopt selectively the deregulatory
proposals from this Report while quietly ignoring the
disclosure enhancements and supplemental filing obligations
that this Report also envisions. The proposals in this
Report are part of a balanced and integrated package, which
should not be implemented on a piecemeal basis.
==========================================START OF PAGE 55======
1. Due Diligence Under Company Registration Model and the
Problem of Liability. We share the view clearly stated in this
Report that company registration has not made, and should not
make, obsolete the efforts of the corporation's independent
"gatekeepers" (i.e., its outside directors, accountants, and
underwriters) to verify and monitor the accuracy of the
corporation's disclosures. No less than our colleagues on the
committee, we believe such due diligence efforts play a critical
role in assuring the integrity of our disclosure system. But the
advent of company registration (as the culmination of a shelf
registration system that has efficiently evolved over time so as
to assure issuers increasingly rapid market access) does require
that we rethink how due diligence is undertaken and the level of
liability that can be fairly attached to it.
In the past, concern has been expressed that the rapid pace
and time constraints associated with shelf registration makes due
diligence infeasible.-[1]- Although the available evidence
remains largely anecdotal, we recognize that such a tendency may
exist and could accelerate under a company registration system.
The Report directly addresses this problem by recommending a
mandatory Form 8-K filing at the time of any substantial equity
issuance (i.e., greater than 3% of outstanding shares). As
---------FOOTNOTES----------
-[1]- Compare Merritt Fox, Shelf Registration,
Integrated Disclosure, and Underwriter Due
Diligence: An Economic Analysis, 70 Va. L. Rev.
1005 (1984) and David Green, Due Diligence Under
Rule 415 Is the Insurance Worth the Premium?, 38
Emory L.J. 793 (1989).
==========================================START OF PAGE 56======
strong proponents of such a requirement, we believe that one of
its most important virtues is that it may provide a focal point
for due diligence.-[2]- Because a Form 8-K carries Section
11 liability (unlike a prospectus supplement), we expect that
participating underwriters, the company's senior management, and
its accountants would meet to discuss and review the contents of
the proposed Form 8-K and recent developments during the current
quarter.-[3]- The existence of a mandatory filing
requirement may strengthen (perhaps only marginally) the position
of the underwriters in their negotiations with management over
the conduct of due diligence.-[4]- On balance, we believe
---------FOOTNOTES----------
-[2]- Such due diligence would chiefly focus on whether
material developments had occurred since the date
of the corporation's last filing under the 1934
Act's continuous disclosure system. We do not
mean to imply that verification of prior filings
would necessarily be undertaken at such issuance.
-[3]- Indeed, some recent decisions suggest that the
failure to implement such a review for late-
breaking developments may subject the corporation
and its directors to liability under 11 because
the registration statement and prospectus may as a
result contain material omissions. See Shaw v.
Digital Equipment Corp., 83 F.3d 1194 (1st Cir.
1996) (where offering under a shelf registration
statement occurred near end of quarter, the
failure to disclose downturn during current
quarter that was below analyst forecasts could
constitute a material omission for purposes of 11
of the Securities Act of 1933).
-[4]- In discussions we have had both within the
Advisory Committee and with underwriters and
others, this proposal has been described as the
"Form 8-K speed bump." This may mischaracterize
it. Like a speed bump, it does require the issuer
to focus and pay attention to this filing
obligation, but it does not require any necessary
(continued...)
==========================================START OF PAGE 57======
that such a requirement will better protect the interests of
investors at relatively low cost to issuers.
But here difficulties surface that motivate us to write
separately. To the extent that company registration is adopted
(or that any significant step is taken toward simplifying the
existing system of shelf registration), corporate issuers may
come to make more frequent use of the debt and equity
markets.-[5]- Issuers seeking to make frequent use of
company registration (or the existing shelf registration system)
face a problem, because repetitive debt or equity offerings co-
exist uneasily at best with the statutory structure of the
Securities Act of 1933. By regularly tapping the capital markets
through repetitive offerings, the corporation exposes its
directors to an increased risk of 11 liability under
circumstances that make effective compliance with their statutory
"due diligence" defenses infeasible. Although we have no doubt
that the board should familiarize itself with the contents of the
registration statement in the context of a major public offering,
there is not the same opportunity for factual verification and
searching questioning in the context of smaller, repetitive
---------FOOTNOTES----------
-[4]-(...continued)
braking in the issuance process.
-[5]- If it occurs, such an evolution toward smaller,
more frequent offerings could efficiently reduce
the cost of capital to corporate issuers and might
even parallel the "just-in-time" supply systems
that American issuers have begun to copy from
their Japanese originators.
==========================================START OF PAGE 58======
offerings. Nor is it necessarily efficient to consume the
board's limited time in this fashion. The dilemma then is that
either (1) board members are over-exposed to liability because
they cannot establish their due diligence defenses within these
compressed time frames, or (2) the corporation must forgo
repetitive offerings because of the legal risks to its directors.
Neither option is attractive; nor is this choice necessary.
This example illustrates a more general point: "company
registration" represents a movement away from a transaction-
oriented system of disclosure. But the liability rules of the
Securities Act of 1933 remain transaction-oriented. As a result,
a mismatch arises, which, we submit, requires that the liability
provisions of the federal securities laws also be re-assessed.
Of course, such an undertaking invites some controversy, but it
is today a feasible project now that the Private Securities
Litigation Reform Act of 1995 has given the Commission broad
exemptive authority under both the Securities Act of 1933 and the
Securities Exchange Act of 1934.-[6]-
---------FOOTNOTES----------
-[6]- See Section 27A(g) of the Securities Act of 1933,
15 U.S.C. 77z-2(g), and Section 21E(g) of the
Securities Exchange Act of 1934, 15 U.S.C. 78u-
5(g). We are, of course, aware that the
Commission has not yet spoken to the scope of its
exemptive authority under these sections. We
believe, however, that courts would defer to any
"reasonable" construction of these provisions
advanced by the Commission. See Chevron U.S.A. v.
Natural Resources Defense Council, Inc., 467 U.S.
837 (1984). The pending Securities Investment
Promotion Act of 1996 would also greatly enhance
the Commission's exemptive authority in even
clearer statutory language.
==========================================START OF PAGE 59======
How might the liability provisions of the Securities Act of
1933 be modified? Less we be misunderstood, we stress at the
outset that we do not seek to abolish liability under 11 or 12.
Although there are multiple forces that drive our disclosure
system, the risk of liability is one of the most significant, and
it motivates independent gatekeepers to test and, if necessary,
challenge the issuer's proposed disclosure. The proposed Form 8-
K requirement (which we support) at least technically increases
the risk of 11 liability for both board members and
underwriters.-[7]-
In seeking to strike the proper balance, we believe the
proper starting point is to define a realistic role for
gatekeepers that is sensitive to both the time constraints
imposed on issuers and underwriters by the marketplace and the
character of the modern board of directors. When the Securities
Act of 1933 was drafted, both were very different. Corporate
boards were then insider-dominated with few truly independent
directors, and as a result it was natural to assume that board
members would be familiar with all material pending corporate
developments. The modern board is now predominantly composed of
outside directors, who are not necessarily familiar on a daily
basis with all material information concerning their corporation
---------FOOTNOTES----------
-[7]- On the other hand, fulfillment of this duty may
serve to protect directors and underwriters from
liability for material omissions relating to
developments subsequent to the issuer's last Form
10-Q. See Shaw v. Digital Equipment Corp., supra
n.3.
==========================================START OF PAGE 60======
and who have other commitments and business obligations that
preclude them from devoting unlimited time to the corporations
they serve as outside directors. Correspondingly, where once a
public offering of debt or equity securities was a long, drawn-
out process which permitted ample time for conducting a due
diligence review, it can now occur from conception to
consummation under shelf registration within the space of a
single day. As a result, the full board of directors, dispersed
in the typical case across the country and subject to their own
time constraints, often cannot undertake a meaningful due
diligence review, at least not within the compressed time frames
that the equity marketplace imposes.
What then can be done without sacrificing the idea of
independent gatekeepers? The modern board necessarily functions
through specialization and delegation. Thus, one of us has
recommended (and the Advisory Committee has accepted) the idea of
a disclosure committee in which the "due diligence" gatekeeping
function would be largely centralized. Such a committee, which
would in all likelihood be a subcommittee of the audit committee,
would meet with the underwriters, senior management, and the
outside accountants to review the corporation's disclosures and
its proposed Form 8-K. Directors not on this committee would be
entitled to rely on the efforts of such a committee (at least
provided that their reliance was reasonable and they did not have
any objective reason to doubt its performance and did not
==========================================START OF PAGE 61======
otherwise lack confidence in the accuracy of the corporation's
disclosures or financial statements).
Even if the logic of our proposal is sound, movement toward
it will not come automatically. Rather, the Commission must hold
out positive incentives to encourage its adoption. Here, the
Report stops short of addressing these necessary incentives. One
such incentive would be a clear right on the part of the other
directors to rely on such a committee, much as directors may do
under the common law or statutory provisions in most states.
Even more importantly, however, the SEC would need to face and
address the liability of the disclosure committee members,
themselves. Easy as it is to say that the rest of the board can
rely upon the disclosure committee, this policy will not work if
outside directors are unwilling to staff such a committee for
fear of enhanced liability. As a practical matter, we doubt that
practitioners will counsel directors to adopt such a committee or
to serve on it -- absent clearer SEC guidance.-[8]- Such
SEC guidance could take a variety of forms: safe harbors, a
burden shifting rule, or some fuller specification of what the
committee should do. For example, when the disclosure committee
has engaged in a specified review of the corporation's financial
---------FOOTNOTES----------
-[8]- Indeed, the early commentary on a publicly
circulated draft of this Report has focused on
exactly this problem. See Roberta S. Karmel,
Deregulation: Real or Alleged, N.Y.L.J., June 20,
1996, at 3, 7 (noting that "there would be no
diminution in 11 liability under the Securities
Act . . ." under the Advisory Committee Report).
==========================================START OF PAGE 62======
statements and '34 Act filings, the Commission might exercise its
exemptive authority to shift the burden of proof under 11 to the
plaintiff to prove that this investigation was inadequate. Such
a change would not wholly absolve committee members from
liability, but it would require the plaintiffs to prove by clear
and convincing evidence that the investigation that they did
conduct was unreasonable under the circumstances.
Beyond this change, a more general principle might also be
recognized: the diligence that is due should be proportionate to
the size and character of the offering. Today, the leading
precedents that guide practitioners -- Feit v. Leasco Data
Processing Equip. Corp.,-[9]- and Escott v. Bar Chris
Construction Corp.-[10]- -- deal with major offerings by
high-risk companies. These cases are clearly correct on their
facts, but they do not address the nature of the investigation
that should be required by outside directors or underwriters in
proportionately smaller offerings by established companies with
rapid access to the market under a company registration system in
order to establish a "reasonable investigation" defense under
11. Here again, SEC guidance is necessary if the board and the
underwriters are to play a meaningful role as a gatekeeper in the
disclosure process.
---------FOOTNOTES----------
-[9]- 332 F. Supp. 544 (E.D.N.Y. 1971).
-[10]- 283 F. Supp. 643 (S.D.N.Y. 1968).
==========================================START OF PAGE 63======
We, of course, recognize that a single Advisory Committee
cannot address every issue, and this committee was not selected
to address legal issues. Nonetheless, the Report concludes
without proposing ways to update the liability rules under the
federal securities laws to mesh with its proposed new disclosure
system. As a result, the paradigm shift that this Report
envisions is incompletely articulated.
Gatekeeper liability makes sense only when the gatekeeper is
placed in a position to take effective preventive action.
Strategies such as the disclosure committee may enable a board
committee to play a meaningful gatekeeper role in the disclosure
process. But, to induce the corporation to form such a committee
or outside directors to staff it, some relief from the "in
terrorem" liabilities of 11 is necessary. In the last analysis,
a choice must be made between (1) abandoning the idea of a
gatekeeper role for the outside director (as some have
argued)-[11]- and (2) focusing the liability provisions of
the federal securities laws so they encourage the performance of
clearly specified responsibilities, but expose the board to no
greater liability than is necessary. That choice has not yet
been made and now falls to the Commission.
(2) Adopting Company Registration Via the Backdoor.
We are concerned that the recommendations of the Advisory
Committee could be adopted in a selective, piecemeal fashion that
---------FOOTNOTES----------
-[11]- See, e.g., Green, supra n.1.
==========================================START OF PAGE 64======
yields greater deregulation but little or no qualitative
improvement in our disclosure system. If there were to be
significant deregulation of the existing shelf registration
system without the concomitant adoption of mandatory disclosure
enhancements or the proposed Form 8-K filing obligation, this
would be the net result.
Even if company registration is adopted as a voluntary opt-
in system, there may be inadequate incentives for issuers to
elect it. Inevitably, issuers will compare company registration
with shelf registration. Here, one of the principal attractions
of company registration over shelf registration is that it gives
the issuer greater flexibility by permitting the issuer in effect
to register and sell all its outstanding shares without
substantive restrictions. In contrast, Rule 415 permits a shelf
registration statement in the case of an "at the market offering
of equity securities" to register no more that "10% of the
aggregate market value of the registrant's outstanding voting
stock held by non-affiliates of the registrant."-[12]-
Although this limitation seems significant at first glance, the
staff's interpretation of this provision has minimized its actual
impact. For example, we have been informed by the staff that it
does not read the 10% ceiling on shelf registration to apply to a
fixed commitment underwriting, even when the offering is done at
the last closing price of the issuer's stock on a stock exchange.
---------FOOTNOTES----------
-[12]- See Rule 415(a)(4)(ii), 17 C.F.R.
230.415(a)(4)(ii).
==========================================START OF PAGE 65======
In such a case, we were told, the offering will not be deemed an
"at the market" offering. As a result, the relative incentive to
opt into a voluntary company registration system dissipates to
the extent this ceiling on shelf registration is relaxed.
Indeed, while an offering under company registration will
sometimes be subject to staff review (if it is in excess of a
specified percentage of the company's outstanding shares), no
such review will occur under the current system if the offering
is properly structured and the company has filed an unallocated
shelf registration statement.-[13]- We point to this
example not to protest it, but simply to illustrate how weak the
incentives may be to elect into a voluntary company registration
system, especially in light of the growing use of unallocated
shelf registration statements.
In contrast, the regulatory requirements associated with
company registration are real. Chief among these are the
mandatory Form 8-K filing obligation, the certification
requirement, and the senior management report. Although the Form
8-K filing may serve to promote a current review of developments
subsequent to the corporate issuer's last filing under the
Securities Exchange Act of 1934's periodic disclosure system (and
---------FOOTNOTES----------
-[13]- If the Commission adopts its proposed rule to make
reporting of probable and material acquisitions
the same under the Securities Act of 1933 and the
Securities Exchange Act of 1934, an unallocated
shelf registration statement will seemingly give
more predictable market access than would be
available under company registration.
==========================================START OF PAGE 66======
this could reduce corporate liability), it is undeniable that
many issuers will view this requirement (and the other new
mandatory features associated with company registration) as
increased burdens, particularly because any periodic report that
is incorporated by reference into the registration statement will
carry 11 liability. In contrast, a prospectus supplement does
not carry 11 liability (nor will it create 12(2) liability for
the corporation's directors because they are not in privity with
the buyers). Hence, this disparity between the legal status of a
Form 8-K filing and a prospectus supplement may cause corporate
counsel to prefer shelf registration to company registration.
We see only one answer to this problem: level the playing
field by extending the new requirements to shelf registration as
well.-[14]- In our judgment, these requirements are
justified because they should enhance the quality of disclosure
to the secondary market. We realize that this proposal will not
be popular in some quarters. Still, unless it is implemented,
the prospect is remote in our judgment that many issuers will
adopt company registration.
---------FOOTNOTES----------
-[14]- We recognize that the Advisory Committee Report
does recommend that the Form
8-K filing obligation be extended to shelf registration as
well as to company registration, but we are concerned that,
unless highlighted, this recommendation may receive
inadequate attention.
==========================================START OF PAGE 1======
APPENDIX A
THE IMPACT OF THE CURRENT REGULATORY SYSTEM
ON INVESTOR PROTECTION AND CAPITAL FORMATION
I. Introduction . . . . . . . . . . . . . . . . . . . . . . .
II. Direct and Indirect Costs and Uncertainties Resulting From
the Registration Process for Public Offerings . . . . . . .
A. Costs of Registration - The Offering Process . . .
1. Direct Costs Associated with the Public Offering Process
2. Delay and Uncertainty Caused by Commission Staff Review
3. Residual Costs Associated With Registering Equity
Securities On Shelf Registration Statements --
Pre-offering Filing Fees, Short-Selling and Market
Overhang . . . . . . . . . . . . . . . . .
B. Indirect Costs Associated with the Current Regulatory
Scheme . . . . . . . . . . . . . . . . . . . . . . .
1. Securities Act Concepts Designed to Ensure the
Registration of Public
Offers and Sales Can Produce Unnecessary Costs and
Uncertainties and Reduce Flexibility in Structuring
Financing Transactions . . . . . . . . . . . . . .
ù Gun-jumping . . . . . . . . . . . . . . . . .
ù Integration and General Solicitation
Doctrines . . . . . . . . . . . . . . . . . .
ù Constraints on Resales - Statutory
Underwriters and Affiliates . . . . . . .
2. Mandatory Prospectus Disclosure Requirements Do Not Meet
Investor Needs in the Most Efficient Manner . . . . .
III. Changes in the Markets and Offering Processes, and the
Effect on Investor Protection . . . . . . . . . . . .
A. Attractiveness of Public, Private and Offshore Markets
==========================================START OF PAGE 2======
B. Blurring of Distinctions Between Public, Private and
Offshore Markets . . . . . . . . . . . . . . . . . . .
C. Growth of Secondary Markets and Changes in Offering
Techniques . . . . . . . . . . . . . . . . . . . .
D. Changes in Gatekeeper Role . . . . . . . . . . . . . . . .
ADDENDUMS TO APPENDIX A
Figure 1: Aggregate Net Issuance of Securities by Domestic Non-
Financial Businesses,
by Year
Figure 2: Total Value of Public Offerings of Equity vs. Trading
Volume in Existing Markets, by Year
Figure 3: Value of Underwritten Public Offerings and Private
Placements of Equity,
by Year
Figure 4: Percent of Issuers Offering Additional Common Stock, by
Year and Type of Filing
Figure 5: Distribution of Waiting Periods, by Review, for Offers
of Additional Common Stock, 1990-94
Figure 6: Fraction of Offers Within Various Size Limits, for
Underwritten Offers of Common Stock, 1992-94
List of Tables
Table 1 Typical Expenses In Underwritten Public Offers of
Common Stock in 1993-95
Table 1b Typical Expenses in Underwritten Public Offers of
Common Stock in 1993-95, for Repeat Offers of $20 to
$200 million by Domestic Issuers, by Value of Offer
Table 2 Typical Experience of Filers of Registration Statements
for Underwritten Public Offers of Common Stock, January
1994 through December 1995
Table 3 Typical Change in Stock Price from Filing to Effective
Date, for Underwritten Public Offers of Additional
Common Stock by 990 NYSE/Amex/Nasdaq issuers, 1993-94,
by Pre-Offer Market Capitalization, and by Whether the
Filing is Reviewed by the SEC
==========================================START OF PAGE 3======
Table 4 Relative Importance of Shelf Registration as a Vehicle
for Securities Sales, by Class of Security and Year
APPENDIX A
THE IMPACT OF THE CURRENT REGULATORY SYSTEM
ON INVESTOR PROTECTION AND CAPITAL FORMATION
I. Introduction
The Committee, in the course of its deliberations,
identified costs associated with the current regulatory process
and disclosure requirements relating to public offerings of
securities, secondary market trading and corporate reporting.
The Committee then investigated the extent to which the benefits
derived from the existing regulatory structure continue to
justify the identified costs. Although significant progress has
been made by the Commission over time to streamline the capital
formation process, particularly through the adoption of the
integrated disclosure system and shelf registration, domestic
capital formation through public securities offerings continues
to be hampered by costs and uncertainties associated with the
registration process. These costs include both direct and
indirect costs created by the registration process, including
costs resulting from the increasingly complex, and often
ambiguous, legal distinctions that have evolved to protect that
process.
The current regulatory system crafted during the era of the
Great Depression does not fully and most efficiently meet the
needs and realities of today's markets, which are increasingly
complicated by modern financing techniques, technological
advancements, globalization, and changes in investor profiles and
demands. These developments bring into question whether all
==========================================START OF PAGE 2======
types of companies should be subject to the current Securities
Act's transactional registration requirements each time they
desire to raise capital in the public markets. After concluding
that the current structure was imposing unnecessary costs, while
not fully taking into account the needs of today's investors, the
Committee determined to recommend a shift in the focus of the
regulatory structure from the current transactional system to a
company registration system that would reduce these costs while
enhancing investor protection.
II. Direct and Indirect Costs and Uncertainties Resulting From
the Registration Process for Public Offerings
The current registration scheme imposes indirect and
direct costs. The indirect costs include uncertainty
and delay arising from the possibility of Commission
staff review (including the possibility of losing a
market window), market overhangs, short-selling and
related activities, and publicity constraints. Direct
costs include legal, accounting, underwriting, printing
and filing fees.
A. Costs of Registration - The Offering Process
1. Direct Costs Associated with the Public Offering
Process
The public offering process can be costly for issuers. For
smaller companies and newer entrants to the capital markets, the
fees paid to the Commission, state regulators, accountants,
lawyers, underwriters, and financial printers amount to a larger
percentage of offering proceeds than for more seasoned issuers.
However, the absolute amount of these direct costs also can be
significant for more seasoned issuers. Generally, direct costs
are higher for offerings of common stock compared to bonds. From
January 1990 through December 1994, it is estimated that the
==========================================START OF PAGE 3======
direct costs of raising capital in public offerings averaged 2.2%
of proceeds for straight debt, 3.8% for convertible bonds, 7.1%
for repeat offerings of equity by seasoned issuers, and 11.0% for
initial public offerings of equity.-[1]-
Table 1 below, prepared by the Committee staff, shows the
breakdown of the components of the direct costs of public
offerings, focusing on offerings of common stock from January
1993 to December 1995. Underwriter's compensation (spread) is
the largest component of floatation costs, typically amounting to
5.3% of proceeds in repeat offerings and 7% of proceeds in
initial public offerings. Systematic underpricing, as measured
by the discount from market price, constitutes the second largest
component, typically amounting to 1.2% of proceeds in repeat
offerings and 7.1% in initial public offerings. Summing these
costs and all other direct fees (for lawyers, accountants,
printers, and regulators), the total cost of raising capital
through public offerings of common stock typically amounts to
7.3% of proceeds in repeat public offerings and 16.9% in initial
public offerings. Table 1 also provides data on floatation costs
broken down according to the type of filing used to register the
stock, and shows that typical costs are lowest for issuers using
Form S-3 shelf offerings (5.0%) and highest (almost 20 - 30%)
among the small-business filers that use Form
---------FOOTNOTES----------
-[1]- Inmoo Lee, Scott Lockhead, Jay Ritter and Quanshui
Zhao, The Costs of Raising Capital, Journal of
Financial Research, Vol. XIX, No. 1, pp. 59-74
(Spring 1996).
==========================================START OF PAGE 4======
SB-2.-[2]-
---------FOOTNOTES----------
-[2]- Form SB-2 is a short-form registration statement
available to small businesses. One reason, seen
in Table 1, that the offering costs for SB-2
filers is a higher proportion of proceeds is that
the typical SB-2 offer yields just $6 million in
proceeds, compared to $78 million for shelf
offerings.
==========================================START OF PAGE 5======
__________________________________________________________________________________________
Table 1
Typical Expenses In Underwritten Public Offers of Common Stock in 1993-95
Registration Number Median Median Median Median Sum
Form Used Value Under- Fees Discount
of writer (a)
Offer Spread from
(millions Market
dollars)
Price
(b)
Initial SB-2 408 $6.1 10.0% 7.4% 11.5% 28.9%
Offer of
Common
Stock by
Domestic
Issuer
S-1 1201 30.1 7.0 2.3 7.1 16.4
S-2, S-11 100 131.7 6.5 1.8 1.1 9.4
Sub-Total 1709 24.0 7.0 2.8 7.1 16.9
Repeat SB-2 99 7.9 9.0 4.5 5.4 18.9
Offer of
Common
Stock by
Domestic
Issuer
S-1 468 32.0 5.5 1.3 2.4 9.2
S-2, S-11 192 20.4 6.0 1.7 2.3 10.0
S-3, Non- 751 59.1 5.0 0.6 0.7 6.3
shelf
S-3, Shelf 136 77.6 4.6 0.4 0.0 5.0
(c)
Sub-Total 1646 44.8 5.3 0.8 1.2 7.3
Overseas F-1, F-2, 214 65.1 5.1 2.1 1.3 8.5
Issuer F-3
Total 3569 $32.5 6.8% 1.8% 2.8% 11.4%
Source: Securities Data Corp. Includes firm commitment underwriting
only.
Notes: (a) Fees include SEC and state filing fees, listing fees, legal
fees, accounting fees, printing costs, and other miscellaneous fees.
(b) The discount from market captures underpricing of offers, measured
here by the first-day return, calculated as the percentage change from
the offer price to the market price at the close of trading on the
offer date. (c) Since there can be multiple offers (takedowns) from
shelf registrations, calculations for this category are based on the
first takedown of common stock.
__________________________________________________________________________________________
Table 1b
Typical Expenses In Underwritten Public Offers of Common Stock in
1993-95, for Repeat Offers of $20 to $200 million by Domestic Issuers,
by Value of Offer
Value Registration Number Median Median Median Median Sum
of Offer Form Used Value Under- Fees Discount
(million of writer (a)
dollars) Offer Spread from
(millions Market
dollars) Price
(b)
$20.0 S-1 167 $32.4 5.5% 1.2% 2.3% 9.0%
to
$49.9
S-3, Non-Shelf 226 34.7 5.5 0.8 1.2 7.5
S-3, Shelf 28 33.8 5.0 0.7 0.0 5.7
$50.0 S-1 99 62.1 5.0 0.7 1.1 6.8
to
$99.9
S-3, Non-Shelf 250 66.9 5.0 0.5 0.7 6.2
S-3, Shelf 49 72.2 5.3 0.5 0.0 5.8
$100.0 S-1 31 125.9 4.5 0.3 1.4 6.2
to
$199.9
S-3, Non-Shelf 135 128.1 4.0 0.3 0.5 4.8
S-3, Shelf 30 130.8 3.5 0.3 0.0 3.8
Source: Securities Data Corp. Includes firm commitment underwriting
only.
Notes: (a) Fees include SEC and state filing fees, listing fees, legal
fees, accounting fees, printing costs, and other miscellaneous fees.
(b) The discount from market captures underpricing of offers, measured
here by the first-day return, calculated as the percentage change from
the offer price to the market price at the close of trading on the
offer date.
Floatation costs are higher for small business issuers for
reasons unrelated to regulation, but a differential regulatory
==========================================START OF PAGE 6======
burden is the best explanation for the lower floatation costs
experienced by S-3 issuers as compared to S-1 issuers. For
repeat offerings of common stock by seasoned issuers, S-1 issuers
incur costs totalling approximately 9.2% of proceeds, whereas S-3
(non-shelf) issuers incur costs totalling approximately 6.3% of
proceeds, and S-3 (shelf) issuers incur costs totalling 5.0% of
proceeds. These differences are only partly attributable to the
larger offer size seen in offerings on Form S-3. Table 1b below
reports typical offering costs for various sized offers, and a
pattern of lower costs for offerings utilizing Form S-3 is found
within each size-based subgroup.
Table 1b - see accompanying link
==========================================START OF PAGE 7======
The single largest determinant of the lower costs seen in
the S-3 shelf filings is the ability to distribute the securities
at the current market price upon takedown, rather than at a
discount to the market price as seen in offerings utilizing Form
S-1 or Form S-3 non-shelf. These cost savings are indicative of
the benefits of "just-in-time" financing techniques that would be
available to company-registered issuers. It is the Committee's
hope and expectation that an increase in an issuer's flexibility
to go to market in a more streamlined manner could result in
further reductions in the direct costs of public offerings.
Lower direct costs could translate into lower costs of capital in
numerous ways. Allowing for the adoption of just-in-time capital
techniques, whereby companies can access the market exactly when
they want and for the exact amount they want, will help eliminate
the discount from the market price currently experienced in non-
shelf public offerings of common stock. In addition, by
extending the benefits of the streamlined offering process and
creating greater flexibility regarding the delivery of disclosure
documents to investors, underwriting, legal and printing costs
should be reduced further.
==========================================START OF PAGE 8======
2. Delay and Uncertainty Caused by Commission Staff
Review
The time consumed by the registration process represents an
indirect cost for issuers. Under the current system, no sales
of securities are allowed until the Commission has declared a
registration statement to be effective. During this waiting
period, the length of which may be affected by whether the
Commission staff reviews the document, issuers may miss a desired
market window.
Under the current Commission staff's selective review
criteria, all registration statements for initial public
offerings (IPOs) are reviewed by the staff. In addition,
pursuant to internal selective review criteria, the staff may
choose to review any other registration statement filed with the
Commission, including shelf registration statements when
initially filed to register securities for the shelf. Prior to
filing a registration statement, even the most seasoned issuer
will not know whether its registration statement will be
reviewed, or the length of the time delay resulting from the
review process if there is a staff review. Issuers trying to
sell securities, other than off a shelf registration statement
previously declared effective, consequently cannot predict in
advance exactly when they will be able to go to market.-[3]-
---------FOOTNOTES----------
-[3]- For shelf offerings, the shelf registration
statement may not be used until declared effective
by the staff. And, as a practical matter, most
initial takedowns off a shelf occur shortly after
(continued...)
==========================================START OF PAGE 9======
Often, they will prepare two different time schedules when
planning a public offering -- one assuming Commission review, and
the other assuming no review -- and the difference between these
two timetables can be substantial.-[4]-
If a registration statement is reviewed, the staff does not
comment on the merits of an offering. Rather, the staff
evaluates the adequacy of the issuer's disclosures. Staff review
encompasses the disclosure in the registration statement as well
as in the company's Exchange Act reports and any other documents
on file with the Commission. Under shelf registration, however,
the staff does not review prior to its use the prospectus
supplement containing transactional information that is used in
taking down securities off the shelf for public sale.
After receiving staff comments, issuers may respond to the
issues raised in the comment letter by revising disclosures in
the registration statement and other corporate disclosures
(including possibly Exchange Act reports) to address the staff's
concerns, by explaining in a supplemental letter to the staff why
---------FOOTNOTES----------
-[3]-(...continued)
the registration statement becomes effective.
Thus, the staff review process may still pose a
real impediment to shelf takedowns. However,
because the issuer may register up to the amount
of securities that it expects to issue in the next
two years, and there generally is no post-
effective staff review of takedown prospectuses,
theoretically this delay does not have to occur
frequently.
-[4]- Transcript of May 8, 1995 Advisory Committee
Meeting at 227 (statement of Gerald Backman).
==========================================START OF PAGE 10======
revisions are not necessary, or both. After the issuer resolves
the concerns raised by the staff, the registration statement is
declared effective. In the extreme, where an issuer misses a
market opportunity while responding to the staff's inquiries, the
company will have expended significant funds preparing for an
unsuccessful offering (although, for a shelf issuer where
registration statement has been declared effective, the issuer
can use the effective shelf at a subsequent time). The mere
prospect of such uncertainty and delay may cause an issuer to
forego a registered offering.
Table 2 below provides a Committee staff analysis of recent
issuer experience with staff review, covering the frequency of
review and the average length of waiting periods. These results
are given for registration statements of underwritten offerings
of common stock that were declared effective during 1994 and
1995. During that period, all initial public offerings received
a full review. In addition, pursuant to selective review, less
than one in six Form S-3 shelf and non-shelf registration
statements were reviewed, and approximately one-third of all
other registration statements for repeat offerings were reviewed.
==========================================START OF PAGE 11======
Table 2
Typical Experience of Filers of Registration Statements for Underwritten
Public Offers of Common Stock, January 1994 through December 1995
Registration Number Average Average Number of Percent Average
Form Used Amount Days before Reviewed Number
Registered Effective: by SEC of times
($millions) Amended
Spent Spent Total
at at the
the Issuer
SEC
Initial SB-1 & 122 $20.3 42.6 61.1 103.7 100% 3.3
Offer of SB-2
Common
Stock by
Domestic
Issuer
S-1 641 66.4 38.9 39.3 78.1 100 3.2
S-11 42 198.8 45.5 60.0 105.5 100 4.0
Repeat SB-2 64 24.2 23.8 44.5 68.2 54.7 2.4
Offer of
Common
Stock by
Domestic
Issuer
S-1 310 70.3 16.7 35.4 52.2 33.5 1.8
S-2, S-11 79 67.7 15.6 36.5 52.2 24.1 1.9
S-3, Non- 416 111.1 9.3 22.8 32.1 13.9 1.2
Shelf
S-3, Shelf* 486 284.1 17.5 36.3 53.7 16.0 1.1
Foreign F-1, F-2, 117 205.4 17.0 45.3 62.4 78.6 2.4
Issuer F-3
Source: SEC Division of Corporation Finance. Includes firm commitment
underwriting only. Excludes regional office filings.
* Includes shelf offerings of common stock by the issuer and unallocated
shelf offerings that are not exclusively debt and/or preferred stock;
does not include Commission staff pre-review -- which is never done -- of
the
takedown prospectus; with regard to shelf registration statements, staff
review is limited to the registration
statement when initially filed.
The typical time period between the filing and the
effectiveness of the registration statement was less than three
months for an initial public offering and less than two months
for repeat offerings. Waiting periods may be longer when the
staff's review and comments are extensive and require substantial
==========================================START OF PAGE 12======
revisions to the registration statement before being declared
effective, thereby introducing uncertainty into the capital
formation process. Staff review also reduces the predictability
of waiting periods, i.e., the length of the waiting period will
vary more where the document is reviewed than when not reviewed.
The degree to which waiting periods vary in length is illustrated
in Figure 5 in the Addendum to this Appendix A, which is a
histogram showing the relative frequency with which waiting
periods of various lengths were observed among underwritten
offers of additional common stock during 1993 and 1994. As shown
in Figure 5, the distribution of the length of waiting periods is
more tightly clustered around the average waiting period in the
absence of a staff review. The length of the waiting period also
is influenced significantly, however, by factors separate from
the Commission review procedure, such as whether the disclosure
in the registration statement when initially filed was
significantly deficient, whether the issuer delayed or
significantly altered the structure of the financing after the
registration statement was filed, and whether the issuer's
Exchange Act reports had been recently reviewed by the
staff.-[5]-
---------FOOTNOTES----------
-[5]- Even if a document is not reviewed by the
Commission staff, issuers can and do amend
registration statements prior to effectiveness.
On average, non-shelf registration statements that
are not reviewed are amended at least once prior
to effectiveness (compared to approximately three
amendments if reviewed). Although shelf
registration statements are amended less often
(continued...)
==========================================START OF PAGE 13======
The risk that disclosed information is erroneous, incomplete
or fraudulent is itself a significant uncertainty that can impose
costs on the capital formation process. Thus, a potential
benefit of the retention of Commission review of transactional
disclosure documents arises from efforts by the Commission staff
to compel issuers to disclose more fully information that would
impact market perceptions of the value of the securities to be
issued.
The Committee strongly believes that staff review is
important where the transaction involves IPOs or major
restructurings. In these cases, the issuer in essence is
beginning the disclosure process anew because the bulk of the
information already available to the public, if any, is not as
useful as in the case of a seasoned company doing a routine
financing. In addition, the coverage by analysts and the
efficiency of the markets in reviewing and absorbing the
information and in pricing securities is less effective in these
transactions than with routine repeat offerings by seasoned
companies. By retaining staff review in these instances,
corrective revisions of preliminary prospectuses prior to closing
can enhance the quality of the disclosure provided to investors,
---------FOOTNOTES----------
-[5]-(...continued)
than non-shelf registration statements after
filing with the Commission, non-reviewed shelf
registration statements are amended prior to
effectiveness .5 times versus 2.4 times for
reviewed shelf registration statements (although
presumably some of these amendments in the latter
category are voluntary).
==========================================START OF PAGE 14======
prevent later and more disruptive corrective disclosure, and
reduce an issuer's exposure to litigation. In the case of Form
S-3 eligible issuers doing routine offerings, however, where the
market following these issuers is better informed and efficient,
the benefits of any review process obviously are less
certain.-[6]- Simply put, the efficacy of the continuous
disclosure reporting scheme under the Exchange Act, including the
review by the staff of operating and financial information filed
on Form 10-K and other reports, may render unnecessary the
separate pre-review by the staff of registration statements and
other transactional filings by reporting companies.
Some argue that the possibility of Commission review of
seasoned issuer transactional filings provides significant
deterrent value that serves to increase the quality of public
disclosures. They argue these issuers voluntarily provide
negative material disclosure without the benefit of an actual
review, at least partially due to the possibility that they might
be reviewed. Others argue that the primary motivator in ensuring
proper disclosure is the fact that the issuer is subject to
liability for market fraud and other civil liability and
government enforcement actions for improper disclosures. In this
respect, strict liability under Section 11 for material
---------FOOTNOTES----------
-[6]- In fact, the Division of Corporation Finance
appears to acknowledge this in that it does not
review takedown prospectuses in the context of
shelf registrations and reviews only approximately
14 to 16 percent of Form S-3 (shelf and non-shelf)
registration statements.
==========================================START OF PAGE 15======
misstatements undoubtedly serves to ensure appropriate compliance
with the dictate of full and fair disclosure.
In the Committee's view, it is inherently difficult to
measure or quantify the incidence of or avoided costs related to
false or misleading statements that are never made, either
because of the possibility of staff review or the threat of
liability. The staff of the Committee analyzed stock-price
evidence in an effort to quantify the benefit to investors
provided by the review process with respect to transactional
filings by reporting companies. If the information generated by
the staff review is predominantly negative, and if stock prices
generally reflect publicly available information, then one could
expect Commission reviews, at least in certain instances, to be
associated with declines in stock prices relative to the market,
on average, over the course of the review. Table 3 below
provides evidence regarding the impact of Commission reviews on
filings for underwritten public offerings of additional common
stock by Nasdaq, NYSE and Amex-listed issuers during 1993 and
1994. The evidence in Table 3 shows no statistically significant
difference in the average change in stock prices relative to the
market according to whether or not filings are reviewed.
Even if this data is construed as demonstrating that no new
material information is generated by staff review of these
transactional filings, that result should not be surprising. If
the continuous disclosure requirements (including the threat of
liability) and staff review of periodic reports are working as
==========================================START OF PAGE 16======
intended, then no material company-related information should be
disclosed during the pre-effective review process.
Moreover, the statistical test was only available for repeat
offers by more seasoned issuers, and was only conducted for
exchange-listed and Nasdaq issuers. Therefore, no evidence was
considered on the value added by staff review in initial public
offerings or in the case of the smallest companies, where the
value added by staff review would be expected to be greater.
__________________________________________________________________________________________
Table 3
Typical Change in Stock Price from Filing to Effective Date, for
Underwritten
Public Offers of Additional Common Stock by 990 NYSE/Amex/Nasdaq
Issuers, 1993-94,
by Pre-Offer Market Capitalization, and by Whether the Filing is
Reviewed by the SEC
Percentage Change in Issuer Stock Price
Less Corresponding Percentage Change in
the Market Overall
Medians Means
Market No Review No Review Difference
Capitalization Review Review (t-
statistic)
Under $100 Million -7.0% -8.9% -6.9% -7.4% -0.5%
(0.21)
$100 Million or -1.8% -1.2% -1.3% 0.5% +1.8%
More (1.16)
Difference -5.6% -7.9%
(t-statistic) (5.17) (2.28)
Source: Securities Data Corp. and Center for Research on
Securities Prices. Includes firm commitment underwriting only.
Net-of-Market stock price changes are calculated by subtracting
the change in the CRSP value-weighted portfolio of all exchange-
listed stocks for exchange-listed issuers, or the change in the
value-weighted portfolio of all Nasdaq stocks for issuers traded
on Nasdaq. Percentages changes are calculated over the period
from one day before the filing date through the date the filing
is declared effective. A t-statistic in excess of 1.96 indicates
a difference in means that is statistically significant by
conventional (i.e., 5%) standards.
==========================================START OF PAGE 17======
On balance, and consistent with the thrust of the
Commission's initiatives, the Committee believes that the cost
and uncertainties created by the current Commission staff review
process of transactional filings might be eliminated for most
issuances by large seasoned companies without any adverse loss of
deterrent effect, as long as those transactional disclosures, as
well as the company's periodic and other filed reports, remain
subject to staff review on a routine basis after the transaction,
as well as remaining subject to Securities Act liability. The
possibility that a company's periodic and other filed reports as
well as transactional disclosure could be reviewed after the
completion of the offering should be as effective as the
deterrence currently provided by the possibility of review prior
to going to market.
3. Residual Costs Associated With Registering Equity
Securities On Shelf Registration Statements --
Pre-offering Filing Fees, Short-Selling and Market
Overhang
Recognizing the costs associated with the traditional
registration process and staff review, the Commission over the
last fifteen years has acted to alleviate delays in going to
market by adopting the shelf registration process. This process
allows seasoned companies to register securities in advance for
sale at a later date. Shelf registration gives a company the
flexibility to enter the market quickly by offering the
previously registered securities "off the shelf," either in one
offering or in several tranches. When the company decides to do
such a "takedown," it files with the Commission, and delivers to
==========================================START OF PAGE 18======
investors, a prospectus supplement describing the terms of the
securities and the specific offering. Issuers are permitted to
use the prospectus supplement to market the securities prior to
their sale. Although it may be reviewed subsequent to the
offering, the prospectus supplement is not subject to Commission
staff review prior to its use. Shelf registration also can be
used for secondary distributions by selling shareholders who wish
to time their sales to coincide with favorable market price
movements.
As originally adopted, shelf registration required the
delineation of the specific amount of each class of security to
be registered. In 1992, the Commission amended the rule
governing the shelf procedure to allow "unallocated" or
"universal" shelf registration where companies may register an
aggregate dollar amount of one or more classes of securities
without having to specify the amount of each class of security
that is registered.-[7]-
Table 4 below reports on recent usage of shelf registration
by corporate issuers of additional securities (i.e., repeat
offerings). During the period from January 1992 through December
1995, on a value-weighted basis, shelf registration was used for
approximately one-half of all underwritten offers of preferred
stock and approximately 40 percent of all underwritten offers of
---------FOOTNOTES----------
-[7]- Simplification of Registration Procedures for
Primary Offerings, Securities Act Rel. 6943 (July
16, 1992) [57 FR 32461 (July 22, 1992)] (the
"Primary Offerings Procedures Release").
==========================================START OF PAGE 19======
corporate debt, but only approximately ten percent of all
underwritten offers of common stock. While sellers of additional
common stock are still less likely to use a shelf registration
than are sellers of preferred stock and debt, the year-by-year
changes reported in Table 4 show that sellers are increasingly
using the shelf registration process to sell common stock. In
1992, takedowns from shelf registrations amounted to three
percent of all underwritten offers of additional common stock.
In 1994 and 1995, fifteen percent of the total value of
additional underwritten common stock issues came from shelf
registrations.-[8]- Indeed, a recent Wall Street Journal
article pointed out not only the increase in recent years in the
number of shelf registration statements that include equity, but
also the recent use of shelf takedowns to sell large amounts of
equity in what are essentially "big block trades." -[9]-
Table 4
Relative Importance of Shelf Registration as a Vehicle for Securities
Sales, by Class of Security and Year
Class of Cumulative Volume Shelf Takedowns,
Security of Public Offers, by Year
1992-95 (% of Class Total)
(billions of
dollars)
// Michael Santoli, Block Trades Test Traditions On Wall
Street, Wall St. J., February 9, 1996, at B12B, col. 3
("Santoli") ("Shelf filings that cover equity have steadily
become more common, rising 18% to 110 in 1995 after climbing
26% in 1994").
Shelf Class 1994 1995
Takedown Total 1992 1993
Common 16.8 156.1 3 9 15 15
Stock
Preferred 44.0 89.4 38 47 60 65
Stock
Corporate 661.1 1648.7 48 45 39 33
Debt
Source: Securities Data Corp. Excludes best efforts deals, private
placements, initial public offerings, and all sales of asset-backed
securities.
---------FOOTNOTES----------
-[8]- Of the $9.4 billion in common stock sold using
shelf registration from January 1992 through
December 1994, the Committee staff estimates that
at least $7.6 billion was sold using the
unallocated shelf process.
-[9]- Michael Santoli, Block Trades Test Traditions On
Wall Street, Wall St. J., February 9, 1996, at
B12B, col. 3 ("Santoli") ("Shelf filings that
cover equity have steadily become more common,
rising 18% to 110 in 1995 after climbing 26% in
1994").
==========================================START OF PAGE 20======
One significant deterrent to the use of the shelf
registration process has been issuers' fear of a dilutive "market
overhang." Overhang often depresses the trading price of a
company's stock once a registration statement is filed disclosing
the issuer's plans to issue additional common stock. Generally,
this market overhang effect seems more pronounced for smaller
issuers. Committee member Dr. George Hatsopoulos submitted a
compilation of repeat (mostly non-shelf) offerings of common
stock under $50 million completed in the five-year period ending
August 9, 1994 (1401 transactions) that showed an average decline
of the issuer's stock price by six percent from the time of
filing to the time of the public offering.-[10]- A
---------FOOTNOTES----------
-[10]- Documents for Advisory Committee Meeting, May 8,
1995, Tab C (Letter dated May 4, 1995 from George
N. Hatsopoulos to Commissioner Steven M.H.
(continued...)
==========================================START OF PAGE 21======
comparable analysis is reported in Table 3 above for repeat
offerings of common stock by companies with pre-offer market
capitalization (rather than offer size) of more or less than $100
million. Among smaller issuers, net-of-market stock price
declines averaged approximately seven percent. Among larger
issuers, there was no significant decline in stock prices on
average, indicating that the market overhang effect appears less
pronounced among the class of issuers that initially would be
eligible for the company registration pilot.
Some or all of the decline in the market price of smaller
issuers could be due to anticipation of the dilutive effect of
the new offering. The higher average floatation costs reported
for smaller issuers in Table 1 above are consistent with this
possibility. The market also may view a registration statement
for possible future sales of common stock as a signal that, in
management's view, the price of the stock has peaked. The
evidence in Table 3 above, that price declines are concentrated
among the smaller issuers, is consistent with this view, since
smaller companies generally are less closely followed by
analysts, and the investment community is generally less well
informed about managements opinions.
For these reasons, disclosure of an issuer's intent to issue
a significant amount of equity can be material to investors
particularly with respect to smaller companies. Dr. Hatsopoulos,
---------FOOTNOTES----------
-[10]-(...continued)
Wallman) ("Hatsopoulos Letter").
==========================================START OF PAGE 22======
however, raised concerns that prior public notice of an issuer's
impending sale of additional common stock provides market
arbitragers with an opportunity to sell the stock short, possibly
exacerbating the anticipated price decline.-[11]- As
stated by Dr. Hatsopoulos,
[o]nce an offering is announced, [the arbitragers] sell
the company's stock short with the intent to cover
their short at the offering. Because of fear for such
an activity, we decided many times in the past to do
offerings offshore and register the shares after
completion.-[12]-
It has been reported elsewhere that short sellers tend to be
active in the shares of companies once the company files a
registration statement for a public offering of common stock,
presumably because the pendency of an added supply of common
stock reduces the likelihood that the short seller will be caught
in a squeeze.-[13]- Ultimately, both the company and the
---------FOOTNOTES----------
-[11]- A market participant has described the phenomenon
as a foolproof way to make money. The market has
created a self-fulfilling prophesy about what will
happen when you file: the price goes down, the
short interest goes up, buyers go to the
sidelines, and the deal comes at a much, much
lower price. Bernstein, Some New Buyers Emerge
From Gloom, BioCentury, The Bernstein Report on
BIOBusiness, May 6, 1995, at A3.
-[12]- Hatsopoulos Letter, supra n.10, at 4.
-[13]- It is estimated that short interest during the
period between filing date and offer date is
approximately three times greater than it is in
the three months before the filing date, based on
a sample of 474 offerings of additional common
stock by exchange-listed issuers. See Assem
Safieddine and William J. Wilhelm, Jr., "An
Empirical Investigation of Short-Selling Activity
Prior to Seasoned Equity Offerings," December
(continued...)
==========================================START OF PAGE 23======
existing shareholders suffer as a result of adverse effects on
the market price of the company's stock, which could
significantly raise the cost of equity capital for issuers.
It was particularly because of these issuer concerns with
potential market overhang that the Commission adopted the
unallocated shelf procedure to facilitate the use of shelf
registration for delayed offerings of common stock and
convertible securities.-[14]- The recent upward trend in
the percentage of all underwritten offerings of common stock that
are made using the shelf registration process suggests that the
1992 introduction of the unallocated shelf procedure has met with
some success. However, the continuing need to specify an
aggregate dollar amount of securities to be offered apparently
has perpetuated market overhang concerns. Industry participants
advised the Committee staff that they still recommend against use
of even the unallocated shelf for common stock offerings, except
where the issuer is large enough to be less susceptible to market
---------FOOTNOTES----------
-[13]-(...continued)
1995, Unpublished Paper, Boston College. SEC
rules prohibit short sales of equity securities in
advance of public offerings, but only when the
short sales are covered with securities sold in
the offering. See Exchange Act Rule 10b-21 [17
CFR 240.10b-21].
-[14]- See Primary Offerings Procedures Release, supra
n.7.
==========================================START OF PAGE 24======
overhang or where the issuer already has disclosed their
intention to raise significant equity capital.-[15]-
Although some market participants indicated potential
interest in advance notice to the market of significant equity
offerings, the Committee concluded that simultaneous notice to
the market through the filing of a Form 8-K, as well as
disclosure of the issuer's financing activities in other reports,
should adequately serve to protect the interest of investors
without requiring issuers -- at least seasoned issuers -- to
signal their intentions months in advance. Indeed, in many
instances under the company registration system, public notice of
a specific offering would occur earlier than required today under
shelf offerings, where transactions are disclosed in prospectus
supplements first filed with the Commission up to two business
days after their use. In the Committee's view, the long-term
market overhang effect could be reduced, or even eliminated,
under a company registration system that does not mandate the
advance filing of a registration statement covering a specified
dollar amount of securities, while appropriate notice to the
market of an offering can be expedited through the company
registration Form 8-K filing requirement.
---------FOOTNOTES----------
-[15]- Transcript of May 8, 1995 Advisory Committee
Meeting at 146 (describing staff discussions with
representatives of financial executives and
underwriters); Documents for Advisory Committee
Meeting, July 26, 1995, Tab E (Letter dated July
21, 1995 from Michael Holladay, General Attorney
of AT&T, to the Committee).
==========================================START OF PAGE 25======
There are other limitations to the current unallocated shelf
process that would be eliminated as a result of the
implementation of a company registration system. First, a shelf
may not be used until the shelf registration statement is
declared effective by the staff, perpetuating much of the
uncertainty and delay that the shelf system was adopted to
address. Based upon information available to the staff, as of
December 31, 1994, approximately 58% of the initial takedowns of
securities off an unallocated shelf that included common stock
occurred within 60 days of the initial filing of the Form S-3
registration statement. Approximately 39% occurred within 40
days of the filing. In roughly 50% of the offerings, half the
time between the filing of the registration statement and the
initial takedown occurred prior to the effective date.
Second, the filing fee for shelf registration is non-
refundable and payable at the time of registration rather than
upon the actual takedown of securities (unlike the "pay-as-you-
go" structure of company registration). Third, in most cases,
the issuer only may register on the shelf an aggregate dollar
amount of securities that it reasonably expects to be offered and
sold within the next twenty-four months. Moreover, in the case
of at-the-market offerings of equity securities,-[16]- the
---------FOOTNOTES----------
-[16]- An "at-the-market" offering is an offering of
securities into an existing trading market for
outstanding shares of the same class at other than
a fixed price on or through the facilities of a
national securities exchange or to or through a
market maker otherwise than on an exchange.
(continued...)
==========================================START OF PAGE 26======
offering must be conducted by an underwriter and the amount of
any voting stock that is registered for this purpose may not
exceed ten percent of the aggregate market value of the
registrant's outstanding voting stock held by non-affiliates.
Company registration also would create more flexibility regarding
prospectus delivery than the current shelf system. Shelf issuers
are required to deliver a final prospectus no later than delivery
of the confirmation, and are restricted in the use of selling
materials or term sheets absent prior or simultaneous delivery of
the prospectus. Finally, company registration would make the
streamlined offering process available in connection with
material acquisitions, whereas the current shelf registration
system generally does not.
---------FOOTNOTES----------
-[16]-(...continued)
Securities Act Rule 415(a)(4)(i) [17 C.F.R.
230.415(a)(4)(i)].
==========================================START OF PAGE 27======
B. Indirect Costs Associated with the Current Regulatory
Scheme
1. Securities Act Concepts Designed to Ensure the
Registration of Public Offers and Sales Can
Produce Unnecessary Costs and Uncertainties and
Reduce Flexibility in Structuring Financing
Transactions
Gun-jumping. Any improper soliciting activities prior to,
or during, the registration process (generally referred to as
"gun-jumping" or "beating the gun")-[17]- violate the
registration requirements of the Securities Act. These
restrictions apply to both large, seasoned public companies that
have been publicly reporting for years, as well as small, non-
public companies contemplating an initial public offering. If
the Commission staff determines that gun-jumping has occurred,
the effective date of the registration statement may be delayed
in an effort to mitigate the effects of the improper publicity on
the market.-[18]- Although the Commission's policies in
this area are not intended to restrict the ordinary flow of
information to investors and analysts, the difficulties of
drawing clear distinctions between permitted and prohibited
market communications have led some reporting companies to limit
their ordinary course disclosures to the marketplace while
---------FOOTNOTES----------
-[17]- See generally Stanley Keller, Basic Securities Act
Concepts Revisited, INSIGHTS, May 1995, at 5 (the
"Keller Article").
-[18]- Gun-jumping also can afford purchasers a right of
rescission under Section 12(a)(1) of the
Securities Act.
==========================================START OF PAGE 28======
contemplating or conducting a public offering.-[19]- Thus,
although the gun-jumping doctrine may serve to protect purchasers
in the offering by hindering circumvention of the registration
requirements, it also may chill or delay the disclosure of some
company-related information that is beneficial to the
marketplace. The Committee questioned whether the chilling
effect of the gun-jumping doctrine serves investor protection
when the issuer is required to supply the markets with extensive
public disclosures on an ongoing basis through its Exchange Act
filings.
Integration and General Solicitation Doctrines. In addition
to the statutory "gun-jumping" restrictions, certain technical
distinctions and concepts have evolved to prevent issuers from
evading the protections of Securities Act registration by
publicly distributing unregistered securities through private
placements, or through affiliates acting as conduits to the
public. Such distinctions and concepts have injected a
significant degree of legal uncertainty into the capital
---------FOOTNOTES----------
-[19]- Although not necessarily representing the current
views of the Commission or the Commission staff,
this cautious approach is based upon longstanding
Commission pronouncements in this area. See
Guidelines for the Release of Information by
Issuers Whose Securities Are in Registration,
Securities Act Rel. 5180 (August 6, 1971) [36 FR
16506 (August 21, 1971)] (although companies are
free to publish factual information while in
registration, they must refrain from making
"predictions, projections, forecasts, or opinions
with respect to value"). See also Securities Rel.
5009 (Oct. 7, 1969) [34 FR 16870] and 4697 (May
28, 1964) [29 FR 7317].
==========================================START OF PAGE 29======
formation process, thereby generating additional costs. The
Committee also questioned whether such distinctions are necessary
in the case of a seasoned issuer for which the same level of
information is continuously provided to the markets as would be
provided through the registration process.
Under the federal securities laws, in certain circumstances,
separate offerings that could each independently meet the
conditions for an exemption from registration may be deemed to be
"integrated" into a single offering for which no exemption is
available. The integration test applied by the
Commission-[20]- is intended to prevent issuers from
circumventing the registration requirements by dividing a single
plan of financing into separate offerings in order to obtain an
exemption that would not be available for the entire transaction.
There are a few safe harbors that offer some level of comfort by
assuring non-integration of certain exempt offerings separated by
at least six months from another offering.-[21]- If an
---------FOOTNOTES----------
-[20]- The SEC applies a five-factor test to determine
whether separate offerings are to be integrated,
or combined into a single offering. Integration
may be required when: (1) the offerings are part
of the same financing plan; (2) the offerings are
made for the same general purpose; (3) the same
class of security is issued in each of the
offerings; (4) the offerings are made at or about
the same time; and (5) the same kind of
consideration is to be received in each of the
offerings. See Non-Public Offering Exemption,
Securities Act Rel. 4552 (November 6, 1962) [27 FR
11316 (November 16, 1962)].
-[21]- See Securities Act Regulation D [17 C.F.R.
230.502]; Securities Act Rule 147 [17 C.F.R.
(continued...)
==========================================START OF PAGE 30======
issuer is unable to comply with a safe harbor, depending on the
facts, its otherwise exempt offerings may be integrated,
resulting in a Section 5 violation.
A private offering also may lose its exempt status if, under
the integration test, it is integrated with a registered offering
and considered a single public offering.-[22]- A private
placement of the same security that is the subject of a
registration statement might avoid integration, however, if the
same transaction were structured differently, e.g., if the
registered security was sold off a shelf registration
statement.-[23]- Needless to say, some of these
distinctions have been condemned as "form over substance" and as
"metaphysics."-[24]-
---------FOOTNOTES----------
-[21]-(...continued)
230.147].
-[22]- A completed non-public offering under 4(2) will
not lose its exempt status as a result of a
subsequent registered offering of the same class
of securities. See Securities Act Rule 152 [17
C.F.R. 230.152]. A 4(2) offering will be deemed
completed when the purchasers' investment decision
is finalized, meaning consummation of the
transaction is no longer subject to any conditions
within the purchaser's control. See Black Box,
Inc., SEC No-Action Letter [1990 Transfer Binder]
Fed. Sec. L. Rep. (CCH) 77,256 (June 26, 1990).
-[23]- See Documents for Advisory Committee Meeting, May
8, 1995, Tab H (Memorandum dated April 26, 1995
from William J. Williams, Jr. to the Advisory
Committee).
-[24]- See, e.g., Gerald S. Backman and Stephen E. Kim, A
Cure for Securities Act Metaphysics: Integrated
Registration, INSIGHTS, May 1995, at 18.
==========================================START OF PAGE 31======
Companies that tend to raise capital more frequently can be
unduly burdened by the integration concept. Companies that want
to conduct multiple exempt offerings within a compressed time
frame often are unable to wait the necessary six months to rely
on a safe harbor from integration. Also, issuers that use
securities as consideration for multiple small acquisitions run
the risk of having those offerings integrated -- even in
situations where the acquisitions have been negotiated on a face-
to-face basis between sophisticated parties.
A separate concern arises from the prohibition on general
solicitations in private offerings. The general solicitation
doctrine is intended to prevent a broad-based offer of securities
without the mandated protections of the Securities Act
registration process. Therefore, public dissemination of
information regarding an anticipated or pending private offering
may be deemed to be a general solicitation, which would adversely
impact an issuer's ability to rely on a valid exemption from
registration under the Securities Act.
However, since an unregistered distribution or placement of
a large amount of a public company's securities, particularly
common stock, can have a material effect on the issuer, and can
result in significant dilution of existing shareholders,
information about financing activities can be important to the
market and the company's existing shareholders. The Commission
has attempted to provide some guidance to help issuers
distinguish between acceptable market disclosure and prohibited
==========================================START OF PAGE 32======
general solicitations.-[25]- Nevertheless, news about
private placements is widely disseminated. In fact, third
parties routinely publicize information about pending private
placements, including information that would be outside the
permitted scope of the safe harbor if attributed to the
issuer.-[26]- Ratings are now routinely published
concerning planned private offerings.-[27]- Thus, the
---------FOOTNOTES----------
-[25]- In 1994, the Commission enacted a safe harbor
permitting reporting issuers to disclose publicly
certain limited information regarding proposed
unregistered offerings. Information that is more
pertinent to the offering process, such as the
underwriter's name, may not be disclosed. See
Securities Act Rule 135c [17 C.F.R. 230.135c], as
adopted in Simplification of Registration and
Reporting Requirements for Foreign Companies; Safe
Harbors for Public Announcements of Unregistered
Offerings and Broker-Dealer Research Reports,
Securities Act Rel. 7053 (April 19, 1994) [59 FR
21644 (April 26, 1994)]. In addition, the
Commission has proposed to amend its annual and
quarterly report forms to mandate disclosure of
unregistered placements of common equity (and
common equity equivalents) in an issuer's periodic
reports. See Streamlining Disclosure Requirements
Relating to Significant Business Acquisitions and
Requiring Quarterly Reporting of Unregistered
Equity Sales, Securities Act Rel. 7189 (June 27,
1995) [60 FR 35656 (July 10, 1995)].
-[26]- For instance, publications such as the Private
Placement Letter provide detailed information on a
weekly basis regarding rumored and completed
private placements, often naming the investment
banking firm(s) acting as placement agent or
underwriter and discussing ranges of pricing
information.
-[27]- See Anne Schwimmer, S&P to Rate 144A Bond Deals
Just Like Public Offerings; But Tricky Questions
Still Remain For the Public/Private Hybrid,
Investment Dealers' Digest, March 4, 1996, at 12,
stating that "Standard & Poor's has begun to
(continued...)
==========================================START OF PAGE 33======
boundaries of the general solicitation doctrine are breaking down
since the very information prohibited under the doctrine is
routinely being released to both the market and potential
offerees prior to completion of the private placement. Indeed,
the Commission recently solicited comments on the continued
viability of the prohibition against general solicitation in
private offerings.-[28]-
The general solicitation concept has other consequences that
burden an issuer's flexibility in structuring transactions
without furnishing any counterbalancing investor protections.
For instance, the Commission staff takes the position that the
filing of a registration statement covering a specific securities
offering (as contrasted with a shelf registration), even without
offering activity, may constitute a general solicitation for that
securities offering.-[29]- Consequently, with limited
---------FOOTNOTES----------
-[27]-(...continued)
publicly release ratings on many Rule 144A private
placements -- hammering home the market's view
that most of these private placements are de facto
public bonds behind the private veneer." Moody's
Investors Service already rates 144A deals.
-[28]- Exemption for Certain California Limited Issues,
Securities Act Rel. 7185 (June 27, 1995)[60 FR
35638 (July 10, 1995)].
-[29]- See Circle Creek AquaCulture V, L.P., SEC No-
Action Letter (March 26, 1993)("The staff also is
unable to concur in your view that the prior
registered offering would not constitute a
"general solicitation" for purposes of rule 502(c)
of Regulation D"); Letter from John J. Huber,
Former Director of the Division of Corporation
Finance, to Michael Bradfield, Former General
Counsel of the Board of Governors of the Federal
(continued...)
==========================================START OF PAGE 34======
exceptions, a private offering of the same or similar security
undertaken while a non-shelf registration statement is pending or
immediately following the registered offering could be tainted by
the earlier general solicitation resulting in a Section 5
violation. This result may occur even if the issuer decides to
abandon the public offering and withdraw the registration
statement.
The Commission staff also has viewed the solicitation of
offerees based on the private offering exemption to be
inconsistent with a subsequent filing to register the sale of the
privately offered securities to the same investors.-[30]-
Viewed as a single transaction, the offer was made before the
filing of the registration statement and therefore constitutes
gun-jumping. Such a scenario may arise where the issuer seeks to
"test the waters" by soliciting indications of interest in a
contemplated offering or the issuer files the registration
statement after the purchasers are committed to purchase to avoid
giving them restricted securities (rather than registering the
resale of the securities acquired by the purchasers, as in so-
---------FOOTNOTES----------
-[29]-(...continued)
Reserve System (March 23, 1984) ("The filing of a
registration statement constitutes an offer to the
public and thus a general solicitation of
investors which precludes reliance on the
exemption provided by Section 4(2)").
-[30]- See Summary of Capital Raising, Acquisition and
Other Activity Involving the Division of
Corporation Finance, THE SEC SPEAKS IN 1996, Vol.
1, at 146 (the "Current Issues Outline"); Keller
Article, supra n.17, at 9.
==========================================START OF PAGE 35======
called "PIPES" transactions).-[31]- Section 5, in the view
of the staff, requires that the offer and the sale both be either
private or public.-[32]- Otherwise, the registration of
the sale to investors solicited privately "would deprive public
purchasers from those investors of the protection of
registration."-[33]-
It is questionable whether the validity of exemptions from
registration should depend on slight gradations in the structure
of transactions, especially where the transactions do not differ
in their economic substance. Because in some instances there are
no bright-line tests for determining when separate offerings will
be integrated, some argue that issuers often incur considerable
expense and delay in procuring legal opinions on this point and
in structuring transactions to satisfy formulaic and formalistic
interpretations. Consequently, the Committee concluded that the
integration and general solicitation concepts often needlessly
complicate a company's capital-raising activities. Since in the
case of seasoned issuers, the registration process often does not
provide any additional disclosure concerning the issuer to the
markets, preservation of these concepts can only be justified by
the need to ensure the sanctity of the transactional registration
---------FOOTNOTES----------
-[31]- "PIPES" refers to "private investment, public
equity." Keller Article, supra n.17,
at 7.
-[32]- See Current Issues Outline, supra n.30.
-[33]- Keller Article, supra n.17, at 6.
==========================================START OF PAGE 36======
requirements. The recommended pilot would address these issues -
- at least for those issuers initially eligible for the pilot --
by treating all offers and sales by a registered company as
registered for disclosure and liability purposes, regardless of
whether made on a public or private basis. Once company
registration is extended to all issuers (with whatever additional
protections, if any, are needed for investors), these concerns
could be addressed directly for smaller issuers as
well.-[34]-
Constraints on Resales - Statutory Underwriters and
Affiliates. Although Section 4(1) of the Securities Act provides
an exemption from registration for sales of securities by persons
other than an "issuer, underwriter or dealer," under the current
system registration may be required when "restricted" securities
(securities issued in a private placement) are resold by
investors. Furthermore, the registration requirements place
restrictions on the ability of a person who controls or is
controlled by or under common control with the company, i.e., an
"affiliate," to resell both restricted and unrestricted
securities.-[35]- This restriction also extends to persons
---------FOOTNOTES----------
-[34]- Until such time as the company registration system
completely replaces the current system, other
initiatives may address certain of these issues.
See, e.g., the proposal for "pink herring"
registration of offers, as described in the Report
of the Task Force on Disclosure Simplification to
the Securities and Exchange Commission (March 5,
1996) ("Task Force Report"), at p.31.
-[35]- To ensure that routine trading transactions
between individual investors do not trigger the
(continued...)
==========================================START OF PAGE 37======
or entities that are affiliates of a company that was acquired by
the issuer in exchange for the issuer's securities.-[36]-
Consequently, this restriction may hinder a public company in
using its securities for business acquisitions. These
constraints arise from the broad interpretation of the statutory
---------FOOTNOTES----------
-[35]-(...continued)
disclosure obligations associated with registered
public offerings, Section 4(1) of the Securities
Act [15 U.S.C. 77d(1)] provides an exemption from
registration for transactions by a "person other
than an issuer, underwriter or dealer."
Purchasers from the issuer who sell their
securities nevertheless may be deemed to be
"statutory underwriters," and hence unable to rely
on Section 4(1), if they are found to have acted
as links in a chain of transmission of securities
from the issuer to the public. Section 2(11) [15
U.S.C. 77b(11)] provides that persons who
control, or are controlled by, or under common
control with the issuer shall be considered "the
issuer" for the purposes of determining who is an
underwriter. Thus, distributions of outstanding
securities can trigger the application of the
underwriter concept to require registration if the
sale is by or on behalf of an affiliate of the
issuer. The statutory provision applies even
where the affiliate acquired the shares in the
open market or in a registered offering by the
issuer.
-[36]- When an issuer offers securities in exchange for
other securities in certain business combinations,
or in certain asset acquisitions, the offer and
subsequent exchange may be deemed an offer and
sale for the purposes of the Securities Act.
Securities Act Rule 145 [17 C.F.R. 230.145]. Any
affiliate of the acquired company who receives
securities of the acquiror company and
subsequently resells those securities in public
transactions without registration may be deemed an
underwriter of such securities unless they are
sold in compliance with the quantity limitations
and other restrictions of Rule 144 (except the
holding period requirement). Rule 145(d) [17 CFR
230.145(d)].
==========================================START OF PAGE 38======
definition of "underwriter" set forth in Section 2(11) of the
Securities Act and are intended to protect the integrity of the
registration scheme against the risk of an issuer's indirect
distribution of securities to the investing public through
affiliates or private placement participants. If such a
distribution is deemed to occur through the conduit of a
statutory underwriter, and the issuer is relying on a private
placement exemption, loss of the Section 4(1) exemption by a
seller may cause the issuer to lose its exemption as well.
Despite Commission efforts in adopting and refining Rules
144 and 144A to provide guidance in this area and to limit the
restraints on resales to only those situations where necessary to
provide investor protection,-[37]- significant burdens and
uncertainties remain. The Committee examined whether
restrictions on resales continue to make sense in today's
markets, particularly where the issuer files periodic reports
under the Exchange Act. For these issuers, requiring separate
registration of the resales generally does not provide any
information that has not already been assimilated by the market
---------FOOTNOTES----------
-[37]- The Commission has provided detailed safe harbor
protections under Rule 144 for resales of
restricted securities and affiliate sales that are
subject to various conditions, including holding
periods, limitations on selling methods, and
volume restrictions. Securities Act Rule 144 [17
CFR 230.144]. Similarly, under Rule 144A, the
Commission has provided a safe harbor for resales
of restricted securities to certain large
sophisticated institutions, known as qualified
institutional buyers, or "QIBs," subject to non-
fungibility limitations and other requirements.
Securities Act Rule 144A [17 CFR 230.144A].
==========================================START OF PAGE 39======
from the company's Exchange Act reports. In such instances, the
costs of monitoring compliance with Rule 144 by control persons
and the diminished liquidity of shares held by any officer,
director or substantial shareholder deemed an affiliate, do not
appear to be justified. In addition, the Committee viewed the
resale restrictions imposed on the affiliate of an acquired
company who receives securities in an acquisition as reducing the
incentives for the use of securities as consideration in
acquisitions. As a consequence, both acquirors and acquirees
could incur unnecessary costs, including potentially adverse tax
consequences that may result if the parties resort to an
acquisition for cash instead.
The burdens created by these resale restrictions do not
impact solely on the issuer and its affiliates. Institutional
investors subject to regulatory capital requirements and
liquidity standards, as well as other fiduciaries, must monitor
and limit the amount of restricted securities in their portfolio.
They also must monitor their resales to ensure compliance with
Rule 144 and Rule 144A requirements. The institution's
monitoring can become unduly complicated if it also holds
registered securities of the same issuer, particularly where the
securities are of the same class. It was hard for the Committee
to justify segregation of the same securities based upon the
method of issuance, especially since the subsequent purchaser of
either the registered security or the non-registered security
would rely on the same body of publicly available information to
==========================================START OF PAGE 40======
make its investment decision, regardless of which security was
purchased.
Company registration should eliminate the need for these
restrictions on resales. The pilot, by eliminating most of the
incentives for issuing restricted securities in exempt offerings
and by narrowing the applicability of these resale restrictions
to a much smaller group of those who are otherwise affiliates and
underwriters, will significantly curtail the potentially
unnecessary application of resale restrictions, including in the
context of acquisitions. In this way, the pilot company
registration system will provide a means for issuers to avoid the
costs and risks associated with complying with these legal
concepts adopted to police the transactional registration
process.
2. Mandatory Prospectus Disclosure Requirements Do
Not Meet Investor Needs in the Most Efficient
Manner
The requirement that a prospectus be delivered to investors
in connection with an offering has traditionally been viewed as
one of the most important protections of the Securities Act. In
practice, however, many have begun to doubt the usefulness of
delivery of a mandated disclosure document, particularly where
full information concerning the issuer is readily available
through the issuer's Exchange Act's filings. The delivery
requirement does not appear to justify the costs in terms of the
usefulness of the information provided. Instead of providing
information of the kind and in the amount sought by investors,
==========================================START OF PAGE 41======
issuers often provide legalistic disclosure documents that are
difficult to read, hard to understand, prepared with litigation
in mind, and delivered after the investment decision is
made.-[38]- Although there are no explicit Commission
mandated disclosure requirements in Rule 144A placements other
than from an antifraud perspective, investor demand has resulted
in the use of 144A offering circulars oriented towards providing
useful information to the prospective purchasers prior to their
investment decision. This experience with Rule 144A demonstrates
that meaningful disclosure will be provided even in the absence
of an express delivery requirement, and in fact, may result in
better and more meaningful disclosure delivered prior to, not
after, the investment decision is made. -[39]-
Under the current process, after the filing of the
registration statement but before it is declared effective, the
underwriter may use the waiting period to solicit indications of
---------FOOTNOTES----------
-[38]- Transcript of May 8, 1995 Advisory Committee
Meeting at 156 (statement of Dr. Burton Malkiel).
See also Documents for Advisory Committee Meeting,
September 29, 1995, Tab E (Letter dated September
27, 1995 from The Association for Investment
Management and Research to Commissioner Steven
M.H. Wallman); Task Force Report, supra n.34, at
17.
-[39]- Ironically, the current "all or none" requirements
that impose disclosure and delivery obligations in
registered offerings, but not in exempt offerings,
has the effect of causing issuers to seek capital
in the less regulated markets where investors have
fewer legal remedies. Arie L. Melnik & Steven E.
Plaut, Disclosure Costs, Regulation, and Expansion
of the Private-Placement Market, 10 Journal of
Accounting, Auditing, & Finance 23 (1995).
==========================================START OF PAGE 42======
interest or otherwise market the securities. Other than the
preliminary prospectus, no written materials explaining the
offering may be distributed to investors before the registration
statement is declared effective. Following effectiveness of the
registration statement, the final prospectus containing the
information mandated by Section 10 of the Securities Act must be
sent or given to investors before or at the time written selling
materials are sent or given, as well as before or at the time the
purchaser is sent or given the written confirmation of sale.
Because these restrictions apply only to written statements, not
oral selling efforts, the current system may actually encourage
oral solicitations over written solicitations.-[40]- The
prospectus delivery requirements thus make it difficult to
deliver term sheets or computational material or otherwise
provide useful information in writing to investors prior to the
availability or finalization of all mandated
information.-[41]- Moreover, in those instances where no
preliminary prospectus or selling materials are distributed, the
only prospectus that would ever be received by investors would be
the final prospectus, which is not required to be delivered until
the confirmation of sale. In fact, if the registered securities
are listed on an exchange, the prospectus delivery requirement
---------FOOTNOTES----------
-[40]- Linda C. Quinn, Reforming the Securities Act of
1933-A Conceptual Framework, INSIGHTS, January
1996, at 25.
-[41]- See Kidder Peabody Acceptance Corp. I, SEC No-
action Letter (available May 17, 1994).
==========================================START OF PAGE 43======
may be satisfied merely by the issuer or underwriter delivering
copies of the prospectus to the relevant exchange for the purpose
of redelivery to members of the exchange upon their
request.-[42]-
Company registration will eliminate the often formalistic
and unnecessary burden of physically delivering a formal
prospectus and will provide issuers with the ability to decide
what information to deliver to investors in connection with the
marketing of a securities offering. This additional flexibility
promises to provide investors with more relevant information in a
more timely manner than if across-the-board prospectus delivery
requirements continued to be imposed.-[43]- The proposed
company registration system is crafted to achieve this goal by
requiring information to be provided to the market earlier than
under the current system, by permitting the provision of the
---------FOOTNOTES----------
-[42]- Securities Act Rule 153 [17 C.F.R. 230.153]. In
addition, Securities Act Rule 174 [17 C.F.R.
230.174] exempts transactions in securities of a
reporting company from the requirement under
Section 4(3) of the Securities Act [15 U.S.C.
77d] that dealers deliver a prospectus to
subsequent secondary market purchasers of the
registered securities for a period of time after
the registration statement has been declared
effective.
-[43]- In the words of one Advisory Committee member, "I
am thoroughly convinced that a one-page prospectus
would actually give investors more information and
more protection and not less." Transcript of May
8, 1995 Advisory Committee Meeting at 157-158
(statement of Dr. Burton Malkiel).
==========================================START OF PAGE 44======
information to be more flexibly structured, and by requiring the
information to be subject to statutory liabilities.
==========================================START OF PAGE 45======
III. Changes in the Markets and Offering Processes, and the
Effect on Investor Protection
The increasing blurring of the lines between public,
private and offshore markets, the general shift of
investment volume from the primary markets to the
secondary trading markets, and the historical reform of
the public offering process to facilitate capital
formation have resulted in new offering and investment
practices. These changes have raised concerns
regarding the effectiveness of the regulatory process
and traditional "gatekeeping" functions. Investor
protection may be adversely impacted where the burdens
of the registration process cause issuers to raise
capital in the private and offshore markets absent the
protections of registration.
A. Attractiveness of Public, Private and Offshore Markets.
Despite significant Commission efforts over the years to
streamline the registration process, the domestic private
placement market, as well as offshore markets, remain an
important source of capital for U.S. companies. In the
Committee's view, the ready availability of the private and
offshore markets as alternatives to the registered public markets
as sources of capital, as well as the interrelationship of these
markets, must shape the regulatory policy for public offerings if
the regulatory scheme is to meet its investor protection
purposes.
Although difficult to quantify because public disclosure of
such information is limited, it is thought that legal and
accounting fees are not likely to be as high in transactions
effected in non-public and offshore markets as compared to non-
==========================================START OF PAGE 46======
shelf offerings made in the public market.-[44]- Non-
registration, however, also may involve significant costs.
Historically, securities have been offered in the private
placement market at significant discounts to prevailing market
prices, representing a significant cost of raising capital for
issuers.-[45]- One reason for this discount is that
investors in private placements (and certain other exempt
offerings and offshore offerings) often must accept a "holding"
period of illiquidity as "the price of the issuer's outflanking
the Commission's registration procedures."-[46]- In
return, investors demand and receive a discount from the
prevailing price of the equivalent securities trading in the
public markets. In fact, the Committee staff estimates that the
typical discount from market value seen in private placements of
common stock by NYSE, AMEX, and Nasdaq issuers is approximately
20 percent.-[47]-
---------FOOTNOTES----------
-[44]- Documents for Advisory Committee Meeting, May 8,
1995, Tab D (Memorandum for Members of the
Advisory Committee on the Capital Formation and
Regulatory Processes dated April 25, 1995 from
Edward Greene and Larry Sonsini to Commissioner
Steven M.H. Wallman).
-[45]- See Documents for Advisory Committee Meeting,
March 6, 1995, Tab F (Memorandum dated March 1,
1995 from Professor John Coffee to the Advisory
Committee).
-[46]- Id., at 2.
-[47]- Based on the median discount observed in 67
private placements reported by Securities Data
Corp. in the period January 1992 - December 1994,
where a selling price was disclosed. In many
(continued...)
==========================================START OF PAGE 47======
The offshore markets also are being accessed in lieu of the
domestic public markets. In the 1980s, the increasing
globalization of the world's securities markets, coupled with the
growth and speed of the transactions in the Euromarkets, along
with U.S. companies' increasing interest in diversifying their
shareholder base and the ease of entry into foreign capital
markets, led to a significant increase in offshore offerings of
securities by U.S. issuers. In order to clarify the reach across
national boundaries of the registration requirements of Section 5
for companies raising capital abroad, the Commission adopted
Regulation S in 1990. In doing so, the Commission made clear
that offers and sales of securities occurring outside the United
States are not subject to the registration requirements of
Section 5.-[48]-
Industry participants have advised the Committee staff that
U.S. companies resort to the offshore markets for a number of
---------FOOTNOTES----------
-[47]-(...continued)
cases, however, a selling price was not disclosed.
This discount is many times larger than
corresponding discounts observed in public
offerings and reported in Table 1 above, where the
typical discount is 7.1% for IPOs and 1.2% for
repeat offers.
-[48]- Regulation S provides safe harbors for primary
offerings and resale transactions abroad that
comply with certain conditions, including
prohibitions on resales back into the United
States for certain periods of time. See
Regulation S under the Securities Act [17 C.F.R.
230.901 to 230.904]. See also Problematic
Practices Under Regulation S, Securities Act Rel.
7190 (June 27, 1995) [60 FR 35663 (July 10, 1995)]
(the "Regulation S Release").
==========================================START OF PAGE 48======
reasons, including the desire to avoid the Commission and state
blue sky registration requirements, or even to minimize the
potential risk of loss of exemptions available for private
placements. Some companies also use offshore offerings in
connection with acquisitions because of the costs and other
burdens of complying with Commission and U.S. GAAP requirements
governing presentation of the acquired company's reconciled pro
forma financial statements.-[49]-
B. Blurring of Distinctions Between Public, Private and
Offshore Markets.
The inability to partition markets based on their regulated
or unregulated status suggests that application of regulatory
protections should be focused on the issuer rather than any
particular transaction. By eliminating distinctions based upon
the circumstances under which a security was originally issued,
and instead improving the disclosure publicly disseminated by the
issuer on an ongoing basis, investors in all the markets for the
issuer's securities would benefit.
As stated by Stanley Keller at the May 8, 1995 Committee
Meeting, for all practical and economic purposes, the public and
private markets are merging.-[50]- Any distinctions
---------FOOTNOTES----------
-[49]- See Streamlining Disclosure Requirements Relating
to Significant Business Acquisitions and Requiring
Quarterly Reporting of Unregistered Equity Sales,
Securities Act Rel. 7189 (June 27, 1995) [60 FR
35656 (July 10, 1995)].
-[50]- See Transcript of May 8, 1995 Advisory Committee
Meeting at 208 (statement of Stanley Keller).
==========================================START OF PAGE 49======
between the two markets have become blurred. The traditional
delineations between registered securities and restricted
securities have become confused through the use of strategies to
minimize the impact of the resale restrictions on privately
placed securities. For instance, holders of securities subject
to resale restrictions, including affiliates, holders of
restricted securities issued in private placements, and offshore
purchasers in Regulation S offerings, are resorting to various
hedging techniques (including short sales and equity swaps) to
avoid or reduce the economic impact of such
restrictions.-[51]-
In addition, under certain conditions, issuers may resort to
the use of "A/B exchange offers" to give purchasers of non-
registered securities the benefits of a freely tradeable security
without having to delay the offering by undergoing the
registration process at the original offering stage.-[52]-
---------FOOTNOTES----------
-[51]- See Managing the Managers, The Economist, February
10, 1996, at 19.
-[52]- Under the current system, privately placed
securities may be registered for resale if the
issuer is willing to agree to pay that expense.
Resale registration often occurs promptly after
the closing of the private placement. In the
resale registration statement, resellers must be
named as selling shareholders. Therefore, they
could be subjected to statutory underwriters'
liability under circumstances where it may not be
feasible or economical for them to make a
reasonable investigation of the issuer's public
disclosures. There also is a prospectus delivery
obligation. Pursuant to a line of no-action
letters, the so-called "A/B exchange offer" allows
certain restricted securities to be converted into
(continued...)
==========================================START OF PAGE 50======
In the case of issuers who are already reporting issuers prior to
the issuance of the restricted securities, the structure of this
process seems to be an unnecessary formalism devised to ensure
technical compliance with the transactional mandates of the
Securities Act.-[53]- Further, while difficult to defend
on a legal or economic basis, the Commission's line-drawing
prohibiting the use of the A/B exchange offer for common equity
of domestic issuers, like the non-fungibility requirement of Rule
144A, appears necessary solely to prevent the wholesale
undermining of the current registration scheme, not to protect
purchasers of the securities in the trading markets.
---------FOOTNOTES----------
-[52]-(...continued)
freely tradeable securities through the mechanism
of a registered exchange offer of an identical
security without all of the holders being
classified as underwriters. See Exxon Capital
Holding Corporation, SEC No-Action Letter
(available May 13, 1988). See also Shearman &
Sterling, SEC No-Action Letter (available July 2,
1993). The A/B exchange offer procedure is
available only for nonconvertible debt securities,
certain types of preferred stock, and initial
public offerings or initial listings in the U.S.
of common stock of foreign issuers. See Keller
Article, supra n.17, at 6. This procedure is not
available for common stock of domestic issuers, or
of foreign issuers who already are reporting
companies, nor is it applicable to market
professionals who continue to be considered
statutory underwriters.
-[53]- At the May 8, 1995 Advisory Committee meeting, Mr.
Keller described this process as really like
taking a rubber stamp and just stamping on [the
security] registered. Transcript of May 8,
1995 Advisory Committee Meeting at 208 (statement
of Stanley Keller).
==========================================START OF PAGE 51======
Distribution practices and pricing also reflect a
convergence in public and private markets. What used to be
thought of as public offerings are being done privately under
Rule 144A. Bearing close resemblance to public offerings, Rule
144A placements often are facilitated by investment banking firms
and accompanied by detailed offering circulars making extensive
disclosures regarding the offering as well as the company and its
financial condition. In the traditional private placement arena,
the movement is towards more standardized documentation, which
minimizes the opportunities for investors to negotiate terms or
to conduct individual due diligence.-[54]- Some investment
banks even have combined or closely aligned different practice
groups (both public and private) in order to compete for business
in a competitive marketplace.-[55]-
---------FOOTNOTES----------
-[54]- See ACIC Designs Pamphlet to Make Private Market
User Friendly, Corporate Financing Week, February
20, 1995, at 6. See also Private Placement
Process Enhancements, American College of
Investment Counsel, Transaction Process
Enhancement Committee (January 1995).
-[55]- See Kimberly Weisul, Integrating Private and
Public Product at Merrill; 'The Lines Continuously
Blur' Between Two Teams Sitting 30 Feet Apart on
Merrill's Trading Floor, Investment Dealers'
Digest, August 28, 1995, at 19. In addition, the
same article states that Goldman, Sachs & Co. also
is well-noted for the close collaboration between
its private and public teams. See also Ronan
Donohue, The Private Market's Creative Drive; The
Private Placement Market Has Become So Creative
That the Exotic is Commonplace, Investment
Dealers' Digest, March 4, 1996, at 14 ("Donahue"),
stating that "most investment banks have moved to
house 144A activity under the capital markets
umbrella with all the fervor of syndicate selling
(continued...)
==========================================START OF PAGE 52======
Likewise, on the buy side, the line between debt issued
under Rule 144A and the public bond market also has become
thin.-[56]- Due to the active participation of mutual
funds as both buyers and sellers of Rule 144A debt securities,
liquidity is readily available, even without subsequent
registration.-[57]- In fact, participants in the market
have come to view the designation of a security as a "Rule 144A
security" as more of a technicality rather than as a distinction
of any economic consequence.-[58]-
Further evidence of the blurring of the private and public
markets is provided by recent news articles discussing the
shrinking of the traditional pricing premium on debt offerings in
both the traditional private placement market and the Rule 144A
---------FOOTNOTES----------
-[55]-(...continued)
and screen-based trading. At Salomon,
underwritten 144As are executed like public deals
. . . . Merrill Lynch has practically amalgamated
the two activities, as has Goldman Sachs."
-[56]- See, Donahue, supra n. 55, at 24, stating that
"further evidence emerged during the year that the
fine line between the 144A and the public bond
market is becoming almost gossamer."
-[57]- Mutual Funds Are Key to 144A Bond Liquidity,
Private Placement Letter, September 18, 1995, at
12.
-[58]- As stated by a trader, "I bought a couple of 144As
yesterday and, quite frankly, forgot they were
144As. . . . The forms came across my desk to
remind me. . . . Other than to comply with
technical restrictions, we don't even really think
of 144A as a category." Id.
==========================================START OF PAGE 53======
market.-[59]- With regard to the private placement market,
"ferocious competition has driven down both spreads for investors
and fees for intermediaries."-[60]- Likewise, as the Rule
144A market for the securities of domestic issuers has grown, the
market has become more efficient and liquid, thereby reducing the
illiquidity premium. The liquidity provided by both registration
rights and the A/B exchange offer technique also could be
contributing to the narrowing of spreads in the Rule 144A market.
However, the regulatory burdens for equity are still significant
(with U.S. issuers of common equity generally not being able to
avail themselves of the beneficial treatment under Rule 144A or
A/B exchange offers), thereby still imposing significant costs on
issuers.
---------FOOTNOTES----------
-[59]- See Anne Schwimmer, Should Retail Investors Buy
Private Placements?; "After Three Years, You Can
Sell It to Grandma," Investment Dealers' Digest,
August 28, 1995, at 11. See also Anne Schwimmer,
144A Bond Market Surges with Volume and Liquidity;
Reaches Critical Mass after Years of False Starts,
Investment Dealers' Digest, August 21, 1995, at
12; Rosalyn Retkwa, Private Placements Push for
Strategic Part in Corporate Finance Picture,
Corporate Cashflow Magazine, December 1995, at 26.
-[60]- Welcome to the Free-for-All; Private Placement
Bankers Adjust to a Radically Changing
Marketplace, Investment Dealers' Digest, August
28, 1995, at 14. See also Private Placements
Becoming Cheap Alternative to Public Markets,
Corporate Financing Week, April 17, 1995, in which
market participants state that "[p]rivate
placement yield spreads have tightened and fees
have shrunk to the point where it is often cheaper
for issuers with less than $100 million of debt to
tap the private versus the public market."
==========================================START OF PAGE 54======
In addition, the increasing use of the offshore markets by
U.S. issuers has raised regulatory concerns regarding the
effectiveness of rules separating the offshore and domestic
markets, particularly where the only trading market for the
security is in the United States.-[61]- Due to the resale
restrictions on Regulation S securities, upon issuance, they are
not supposed to trade freely with any comparable securities in
the United States. Consequently, the Regulation S securities,
particularly equity, usually are priced at a discount to the U.S.
market price. Non-U.S. investors may attempt to capture this
spread, however, by creating short positions in the United States
with the intent to cover the position with the lower priced
---------FOOTNOTES----------
-[61]- The legal risk of flowback of securities issued
offshore into the domestic public markets
increases substantially with equity offerings by
U.S. issuers of listed securities, particularly
where there is no market for the securities
outside the United States. See Edward F. Greene
and Jennifer M. Schneck, Recent Problems Arising
Under Regulation S, INSIGHTS, August 1994, at 2
(the Greene/Schneck Article ). Any such flowback
without a valid exemption would expose the issuer
to Commission and private litigation based on the
failure to register the securities. While it is
possible to register for resale securities
initially offered outside the United States
through the use of a "flowback" registration
statement, unless the entire offshore distribution
is registered for flowback, there would be
practical difficulties in determining which of the
securities were registered under the Securities
Act given the fungibility of securities in the
secondary markets. See Ronald R. Adee, Flow-back
Registration Statements, INSIGHTS, April 1988, at
10.
==========================================START OF PAGE 55======
Regulation S securities.-[62]- In the alternative, a non-
U.S. investor with a valid exemption from registration can sell
the Regulation S securities back into the United States upon
expiration of the Regulation S holding period, which can span as
little as 40 days. Thus, the securities placed outside the
United States in reliance on Regulation S may be traded back into
the United States, in some cases almost immediately, with no
investor protection under the Securities Act for any subsequent
purchasers in the United States.
Recent press reports reveal another motive for offshore
offerings.-[63]- Despite technical compliance with
Regulation S's resale restrictions, some issuers reportedly have
used the rule to effect an indirect illegal distribution to U.S.
investors by, among other things, placing unregistered securities
temporarily offshore to evade registration
requirements.-[64]- Similarly, holders of restricted
---------FOOTNOTES----------
-[62]- Greene/Schneck Article, supra n.61, at 6.
-[63]- See, e.g., Jaye Scholl, Easy Money: How Foreign
Investors Profit at the Expense of Americans, An
Invitation to Scamsters?, Barron's, April 29,
1996, at 31; Laurie Cohen, Rule Permitting
Offshore Stock Sales Yields Deals That Spark SEC
Concerns, Wall Street Journal, April 26, 1994, at
C1; Linda C. Quinn, SEC Division of Corporation
Finance Expresses Concern, INSIGHTS, April 1994,
at 36.
-[64]- As stated by the Commission in the recent release
regarding problematic practices under Regulation
S,
it has come to the Commission's attention that
some
market participants are conducting placements
of
(continued...)
==========================================START OF PAGE 56======
securities have attempted to used the resale safe harbor of
Regulation S to "wash" or remove the resale restrictions on those
securities. The premise that the federal securities laws can be
administered on a geographical basis is being further undermined
by the ability of issuers to place offers on the Internet, which
"shows no respect for those boundaries."-[65]- These
developments have raised concerns regarding the effectiveness of
the restrictions under Regulation S in policing the integrity of
the Securities Act registration process.
The effects of the merging of the public, private and
offshore markets on the operation of the current Securities Act
concepts and protections are grounds for significant concern. It
seems clear that these concepts are no longer capable of
achieving their purpose of protecting investors, and are imposing
substantial costs on issuers. In the case of seasoned issuers,
the benefits of attempting to preserve these distinctions are
-[64]-(...continued)
securities purportedly offshore under
Regulation S
under circumstances that indicate that such
securities
are in essence being placed offshore
temporarily to
evade registration requirements with the result
that
the incidence of ownership of the securities
never
leaves the U.S. market, or that a substantial
portion
of the economic risk relating thereto is left
in or is
returned to the U.S. market during the
restricted
period, or that the transaction is such that
there was
no reasonable expectation that the securities
could be
viewed as actually coming to rest abroad.
Regulation S Release, supra n.48, [60 FR at
35664].
-[65]- Michael Salz, Small Stock Issuers Find a New
Market on the Internet, Wall Street Journal, May
14, 1996 at 132 (quoting K. Robert Bertram,
Pennsylvania Securities Commission).
==========================================START OF PAGE 57======
unclear, given the significant costs and reduced investor
protection that comes from them. Rather, with regard to seasoned
issuers, the Committee concluded that investor protection would
be better served by a regulatory model that no longer attempts to
preserve any artificial distinctions among these markets.
Instead, the new regulatory model would provide for Securities
Act protections for all sales to purchasers in the United States
(regardless of whether the securities were first offered abroad),
and would extend the type of discipline and quality of disclosure
traditionally enjoyed by the primary markets to the company's
continuous reporting, for the benefit of all the markets for the
seasoned issuer's securities.
C. Growth of Secondary Markets and Changes in Offering
Techniques. Due to the explosive growth of trading in the
secondary markets as compared to the primary issuance market,
today most investors look to the Exchange Act for protection,
rather than the Securities Act. As shown in Figure 2 in the
Addendum to this Appendix A, with regard to common stock, the
U.S. capital markets have shifted -- on a relative basis -- from
a primary role as a source of capital to a venue predominantly
for secondary trading. As shown in Figure 2, the secondary
trading markets for common equity have grown exponentially in
comparison to the primary issuance market, with over $5,500
billion in secondary trading versus $155 billion in primary
issuances in 1995. The registered primary issuance market for
==========================================START OF PAGE 58======
common stock has remained relatively stagnant as a source of
capital since 1933.-[66]-
From a liability perspective, this shift is significant
since the key liability provisions of the Securities Act offer
protections only to purchasers of securities in the primary
offering, not those purchasing an identical security in the
secondary markets.-[67]- Moreover, since some believe
Exchange Act reports "tend to be taken less seriously, and to be
of lower quality," than documents prepared specifically for use
in registered offerings,-[68]- the ultimate effect on
---------FOOTNOTES----------
-[66]- Figures 1 and 2 to the Addendum to this Appendix
A. In addition, as shown in Figure 1, there has
been a substitution in the primary markets of
corporate debt for equity since 1983.
-[67]- Although a secondary market purchaser who
purchases securities that were originally
registered under the Securities Act technically
would be able to bring a claim under Section 11 of
the Securities Act for material misstatements or
omissions in the registration statement, the
statute of limitations has begun to run with the
initial sale by the issuer and such purchaser must
be able to trace the securities purchased in the
secondary market back to the original registration
statement in order to maintain the Section 11
claim. Also, claims under Section 12(a)(2) of the
Securities Act for material misstatements or
omissions in the prospectus may only be brought
against those in privity with the purchaser or who
otherwise engage in soliciting activities. Pinter
v. Dahl, 486 U.S. 622 (1988).
-[68]- See Milton H. Cohen, The Integrated Disclosure
System -- Unfinished Business, 40 Bus. Law. 987,
992 (1985) ("Cohen, Unfinished Business")
(describing general agreement that the Exchange
Act reports are not of the same quality as the
Securities Act documents). Industry participants
have informed the Committee staff that this
(continued...)
==========================================START OF PAGE 59======
investor protection is potentially far-reaching for both the
primary and secondary markets that price and function on the
basis of those reports.
Even when investors do participate in public offerings of
securities, thereby receiving the protection of the Securities
Act, the prospectus delivery and disclosure requirements have
much less significance in the case of seasoned issuers because
the company-related mandatory disclosure is incorporated by
reference from the issuer's Exchange Act reports rather than
physically delivered directly to purchasers. When Congress
adopted the Securities Act in 1933, it envisioned that
prospective investors would receive a single disclosure document
containing all material information necessary to make an informed
investment decision prior to making such decision.-[69]-
Integrated disclosure and shelf registration have led to an
---------FOOTNOTES----------
-[68]-(...continued)
conclusion is still valid today. See Transcript
of July 26, 1995 Advisory Committee Meeting at 178
(statement of Roland Machold: "I used to write
prospectuses myself and I can remember the first
thing you did was throw away the 10-K and start
from scratch. And I think that still goes on. The
10-K is filled out by clerks and the offering
circular is filled out by people who have
concerns"). See also Documents for Advisory
Committee Meeting, September 29, 1995, Tab E
(Letter dated August 1, 1995 from Robert S.
Merritt, Chief Financial Officer, and Joseph J.
Kadow, Vice President and General Counsel, Outback
Steakhouse, Inc. to Brian T. Borders, President,
Association of Publicly Traded Companies)(stating
that Exchange Act disclosures could be improved).
-[69]- See H.R. Rep. No. 85, 73d Cong., 1st Sess., at 8
(1933).
==========================================START OF PAGE 60======
increasing percentage of the primary issuances of securities by
seasoned companies being made through the streamlined Form S-3
process,-[70]- where less of the disclosure mandated by the
Securities Act is actually being delivered to investors.
Instead, and appropriately, greater reliance is placed on the
integrity of the Exchange Act reports to ensure a fair pricing of
securities by repeat issuers.
Recent rule changes adopted by the Commission to facilitate
prospectus delivery in light of the movement to a three business
day standard settlement time frame ("T + 3"),-[71]- and
interpretive guidance issued by the Commission to assist issuers
in the use of electronic rather than paper delivery of documents
to investors under the federal securities laws,-[72]-
preview the rapid changes occurring in the procedures used in
securities offerings. Already, market participants are permitted
to deliver the statutory prospectus information in more than one
document. Also, such documents may be delivered to investors at
---------FOOTNOTES----------
-[70]- For information regarding the history of repeat
issuances of common equity by seasoned issuers on
Form S-3 over the last ten years, see Figure 4 in
the Addendum to this Appendix A of the Report.
-[71]- See Securities Act Rule 434 [17 C.F.R. 230.434],
as adopted in Prospectus Delivery; Securities
Transactions Settlements, Securities Act Rel. 7168
(May 11, 1995) [60 FR 26604 (May 17, 1995)]; Rule
15c6-1 [17 C.F.R. 240.15c6-1].
-[72]- See Use of Electronic Media for Delivery Purposes,
Securities Act Rel. 7233, Exchange Act Rel. 36345
(October 6, 1995) [60 FR 53458 (October 13,
1995)].
==========================================START OF PAGE 61======
separate intervals and in varying manners, including electronic
delivery. Consequently, actual delivery of a final printed
integrated prospectus to investors prior to or with the
confirmation may soon become a relic of the past.
As a result of these market and regulatory changes, the
traditional transactional registration process may no longer be
directly relevant to investors purchasing the securities of
seasoned issuers. Since so much of the information deemed
necessary for an investment decision is being provided through
the public filing of Exchange Act reports with the Commission,
the Committee believed that the original goals of the Securities
Act would be better served by the adoption of new disclosure
practices and procedures that should have the beneficial effect
of focusing the participants in the capital formation process on
enhancing the quality of the disclosure in these reports.
D. Changes in Gatekeeper Role. According to Milton H.
Cohen, the superiority of Securities Act disclosure is related
directly to the "in terrorem" effect of the statutory liability
provisions of the Securities Act on the issuer's directors,
underwriters, accountants, and other gatekeepers charged with
responsibility for the issuer's disclosure in connection with a
public offering.-[73]- Under the traditional offering
process, ordinarily there would be ample time available before
the filing of a registration statement, and again before
---------FOOTNOTES----------
-[73]- See Cohen, Unfinished Business, supra n.68, at
989.
==========================================START OF PAGE 62======
effectiveness of that registration statement, for these
gatekeepers to exercise their investigatory responsibilities.
The lead underwriter normally participates in the drafting of the
registration statement and undertakes significant investigation
of the company, its business and its management in connection
with an offering. This due diligence obligation has developed
largely in response to the underwriter's exposure to liability
for false or misleading disclosures in the registration
statement. Supporters of the current liability system point out
that it imposes policing responsibilities on those parties best
equipped to judge the accuracy and completeness of registration
disclosures. This disincentive to carelessness created by the
liability structure ultimately benefits investors and the markets
as a whole.
Many in the underwriting and legal communities believe that
it has become increasingly difficult for underwriters to
discharge their due diligence responsibility in the context of
the streamlined offering process afforded by integrated
disclosure and shelf registration. According to a recent report
on due diligence by the American Bar Association's Task Force on
Due Diligence,-[74]- the informational convergence between
the Securities Act and the Exchange Act as a result of integrated
---------FOOTNOTES----------
-[74]- American Bar Association Committee on Federal
Regulation of Securities, Report of the Task Force
on Sellers' Due Diligence and Similar Defenses
Under the Federal Securities Laws, 48 Bus. Law.
1185 (May 1993).
==========================================START OF PAGE 63======
disclosure, and the severe time constraints imposed by shelf
registration, make it difficult, if not impossible, for
underwriters in a shelf takedown to perform a traditional, in-
depth due diligence analysis of the issuer, especially since the
bulk of the required company-related disclosure will be satisfied
through incorporation by reference. Underwriters claim to be
hampered in their due diligence efforts because they typically do
not help prepare the issuer's Exchange Act reports.-[75]-
Thus, with respect to seasoned issuers using the shelf process,
the current system may be suffering from an erosion of the
underwriter's traditional performance of due diligence, one of
the key safeguards against fraud under the Securities Act
liability paradigm.
With the increasing use of the shelf process to conduct
offerings of equity securities, the difficulties highlighted in
the ABA Due Diligence Report may become further exacerbated.
This trend is evidenced by recent reports of large takedowns of
common equity off a universal shelf being directly placed in what
are essentially block trades, as contrasted with the usual
underwritten offering approach.-[76]- Underwriting firms
---------FOOTNOTES----------
-[75]- Documents for Advisory Committee Meeting, November
21, 1995, Tab E (Letter dated November 2, 1995
from the Securities Industry Association to the
Advisory Committee, at 5-7)(the "SIA Letter").
-[76]- Santoli, supra n.9 ("efforts to sell stock
directly are another sign of Wall Street's eroding
role as gatekeeper and disseminator of
information, a process that gathers force with
each new application of communications technology
(continued...)
==========================================START OF PAGE 64======
assert that the shift in the focus of disclosure to the periodic
reports filed under the Exchange Act, as well as the streamlining
of the registration process through the adoption of shelf
registration, without a commensurate change in the statutory
liability structure or the gatekeeper function, is fundamentally
unfair and should be addressed.-[77]-
Members of the board of directors likewise may have cause
for concern under the current liability scheme. Substantial
portions of the Securities Act disclosure requirements are now
being satisfied with information incorporated by reference from
Exchange Act periodic reports. Board members do not tend to pay
as much attention to the preparation of information in a
company's periodic reports as they would if such information was
being prepared directly for a public offering
document.-[78]- Nor are board members positioned to review
either the Exchange Act filings or offering documents in an
environment of frequent offerings conducted with minimal advance
---------FOOTNOTES----------
-[76]-(...continued)
to the investment business").
-[77]- SIA Letter, supra n.75, at 7-10.
-[78]- See Transcript of May 8, 1995 Advisory Committee
Meeting at 166 (statement of Mr. Roland M.
Machold). See also Joseph McLaughlin, Integrated
Disclosure, Shelf Registration and Other Due
Diligence Challenges in the Public Offering
Process, PLI CONDUCTING DUE DILIGENCE 1995 (March
14, 1995), at 2.
==========================================START OF PAGE 65======
planning and little opportunity for a due diligence
review.-[79]-
Finally, the increased significance of the secondary markets
is cause to question the wisdom of focusing the gatekeeper
function on episodic transactions. Indeed, a significant portion
of the reporting companies whose securities are actively traded
---------FOOTNOTES----------
-[79]- During the February 22, 1996 Advisory Committee
meeting, Professor Coffee gave the following
"illustrations:"
I had a conversation [with an outside director] on the
board of a company that has been, for the last six
months, making daily sales of its equity securities to
an underwriter through universal shelf registration.
His problem, as he said throwing up his hands, is there
is no way in the world that we can conduct daily due
diligence. There is nothing in the system that tells
us how we can do it or what we can do to comply with
this kind of world.
He went on to describe to me a case ... of a very major
insurance company that has been told by its
underwriters that it would be very attractive to it to
be able to use the underwriter to make daily small
sales in a manner that would not move the market.
Again, selling equity securities through the market
maybe three or four times a week in small quantities,
but the board of directors and the lawyers of that
large insurance company are very, very concerned that
kind of process of constant sales would expose the
directors to difficulties because there would be no way
that they could, on a constant basis, fulfill their due
diligence responsibilities.
Transcript of February 22, 1996 Advisory Committee Meeting
at 51-52. Professor Coffee observed that one of the
intended effects of company registration -- small, frequent
equity offerings not planned very many days in advance --
would present the same concerns. Id. at 52.
==========================================START OF PAGE 66======
in the public markets never access these markets for new
capital.-[80]- Consequently, apart from the important
discipline of the annual audit, these companies are never
subjected to the type of investigation by others contemplated by
the Securities Act.
The company registration system, by contrast, will help
alleviate some of these concerns by permitting and encouraging
more and better due diligence by those in the position to be most
knowledgeable, without lowering liability standards. By
providing incentives and mechanisms for increased and enhanced
ongoing oversight of a company's disclosures to the market, and
by requiring all material development disclosure, including
transactional disclosure, to be filed as part of the registration
statement at the time of the offering, investor confidence in
both the primary and secondary trading markets should be
heightened, thereby ultimately lowering a company's cost of
capital.
* * *
The increasing inapplicability of traditional transactional
registration concepts in today's undifferentiated markets, the
growth of the secondary markets, the regulatory shift to reliance
on Exchange Act reports, as well as the persistent concerns with
the quality of that disclosure and adequacy of gatekeeper due
---------FOOTNOTES----------
-[80]- See Figure 4 in the Addendum to this Appendix A of
the Report (only 4-6% of NYSE, AMEX and Nasdaq
companies made underwritten offerings of
additional common stock each year since 1985).
==========================================START OF PAGE 67======
diligence in the context of today's expedited offering process,
all point to the conclusion that the existing Securities Act
protections and processes needed to be re-examined. Investor
protection and capital formation would be better served by a
regulatory system that operates to improve the quality and
reliability of a company's continuous disclosure while
eliminating costly transactional registration requirements and
restrictions that no longer serve to protect investors. Improved
disclosure can be accomplished in a number of ways, including by
having senior management and the board of directors focus on and
improve the procedures under which the company's reports are
prepared, and through the adoption of measures to ensure more
timely disclosure of significant developments, as well as through
greater auditor involvement. Measures to reorder and rationalize
the gatekeeper and monitor function to focus on the integrity of
the company's reports on an ongoing, rather than an episodic
basis, will preserve and reinforce the protections afforded by
outside oversight of a company's disclosures.
==========================================START OF PAGE 1======
APPENDIX B
ESSENTIAL ELEMENTS OF THE COMPANY REGISTRATION SYSTEM
I. Disclosure
A. Disclosure and Prospectus Delivery Under the
Company
Registration System
1. Company Registration Statement
2. File and Go
3. Prospectus Delivery
B. Role of the Commission and Other Gatekeepers or
Monitors
1. The Commission Review Process
2. The Underwriter
3. The Auditor
II. Company Eligibility
III. Transactions Covered
A. Affiliate and Underwriter Resales
1. Sales of Restricted Securities
2. Sales by Affiliates
B. Exclusions
C. Offshore Offerings
D. Preservation of Transactional Exemptions
E. Limited Placements
IV. Disclosure Enhancements Under the Recommended Company
Registration Model
A. Mandatory Disclosure Enhancements
1. Enhanced Involvement by Senior Management
==========================================START OF PAGE 2======
a. Top Management Certifications
b. Management Report to the Audit Committee
2. Improvements in the Content and Timeliness of
1934 Act
Reporting
a. More Timely and Informative Reports
on Form 8-K
b. Form 10-K Risk Disclosure
B. Conclusion
V. Liability and Due Diligence Under Company Registration
A. Liability Under Company Registration
1. Other Liability Approaches Considered
2. Preservation and Expansion of Statutory
Liability
B. Due Diligence Under Company Registration
1. Underwriters
2. Outside Directors
C. Conclusion
Addendum to Appendix B -- Comparison of Company Registration
and Shelf Offering Systems
==========================================START OF PAGE 1======
APPENDIX B
ESSENTIAL ELEMENTS OF THE COMPANY REGISTRATION SYSTEM
I. Disclosure
Company registration would further the traditional
goals of the disclosure requirements under the federal
securities laws -- to provide investors with the
information necessary to make an informed investment
decision and to deter fraud and overreaching. While
company registration would maintain and in some cases
expand the level of information about companies and
their offerings that currently is made available to the
markets through Commission filings, such information
would be required to be made public earlier than under
the current system, thereby benefitting investors in
both the primary issuance market and the secondary
trading markets. At the same time, company
registration would afford companies offering their
securities to the public the flexibility to tailor the
disclosure documents delivered to investors to the
nature of the transaction and the demands of the
offering participants. Company registration also would
maintain and reinforce the roles of outside gatekeepers
and monitors and their due diligence functions in
fostering the reliability of that information to meet
the realities of today's markets.
The primary goals of disclosure under the federal securities
laws are to provide investors and the marketplace with
information necessary to make informed investment decisions, and
to deter fraud. Capital allocation decisions are best made on
the basis of well-informed private decision-making by market
participants. In an oft-quoted passage, Justice William Douglas,
who once served as Commission Chairman, stated:
The truth about the securities having been told, the
matter is left to the investor. . . . The requirement
that the truth of the securities be told will in and of
==========================================START OF PAGE 2======
itself prevent some fraudulent transactions which
cannot stand the scrutiny of publicity.-[1]-
Full and fair disclosure is the key to an efficient capital
allocation process. Under the current regulatory scheme for
public offerings, disclosure of information material to
investment and voting decisions is effectuated in two principal
ways. First, information is made public through the filing of a
disclosure document with the Commission. This information then
is available to investors, either directly by investors accessing
the information themselves, or indirectly through intermediaries
such as investment advisers, research analysts, and other
investment professionals who analyze and redistribute that
information to the investing public. The requirement under the
Securities Act that a registration statement be on file with the
Commission before the offering process commences is an example of
this form of disclosure. This method of information
dissemination is also the principal means by which the trading
markets are provided with current information about issuers. The
annual report on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K are examples of this method of
disclosure.
Second, information is disseminated directly to investors by
the issuer of the securities. The Securities Act requirement to
deliver a prospectus to an investor no later than the time the
---------FOOTNOTES----------
-[1]- William O. Douglas, Protecting the Investor, 23
Yale L. Rev. 521, 523-24 (1934).
==========================================START OF PAGE 3======
confirmation of the sale is sent falls into this category, as do
the requirements for delivery of a proxy statement and annual
report to shareholders in connection with an election of
directors, or an offer to purchase in connection with a tender
offer. Prospectuses that are filed publicly with the Commission
likewise serve to inform the trading markets.
Experience has demonstrated that actual delivery of
information to investors -- as opposed to delivery of such
information to the markets through a Commission filing --
frequently is not necessary to convey information and deter
fraud. Public disclosure of information concerning the issuer
through Exchange Act filings, and its consequent ready
availability, serve as an efficient means to facilitate informed
assessments of the issuer's business prospects and financial
condition and the security being offered. Public disclosure also
serves to deter many of the more unsavory practices witnessed
before the adoption of the Securities Act, such as self dealing
by insiders and underwriters. Finally, the public availability
of information also can serve to counteract overzealous selling
efforts.
Milton Cohen, in his seminal article "Truth in Securities
Revisited," established a blueprint for rationalizing the two
securities acts with respect to prospectus delivery:
This is, indeed, an area for pragmatic and not merely
logical answers, and I believe that the best approach
in a coordinated law will be to introduce a greater
degree of pragmatism -- primarily in distinguishing
continuous registrants from others but also in
==========================================START OF PAGE 4======
distinguishing among different types of transactions. .
. .
First, a prospectus of a continuous registrant should not be
required to contain information that is of no different
significance or greater materiality to an offeree in a
distribution than to any other investor or potential
investor in securities of the same issuer. Second, a
prospectus that is not required to be delivered in time to
affect investment decisions should not be required at all,
unless serving a purpose not adequately served by public
filing alone . . . .-[2]-
The Wheat Report, published in 1969, also reflected a
recognition that the traditional prospectus delivery requirements
mandated under the Securities Act may not be the most efficient
means to disseminate information relevant to an investment
decision. First, the unsophisticated investor may not be able to
understand and make use of the information contained in the
prospectus without the benefit of a market
intermediary.-[3]- Second, in any event, because the use of
a preliminary prospectus is not mandated, investors often do not
receive prospectus information until delivery of the
confirmation. In addition, requiring an issuer that was subject
to the continual reporting requirements of the Exchange Act to
put information regarding the company, as contrasted with the
specific offering, in the prospectus was recognized as
---------FOOTNOTES----------
-[2]- Milton H. Cohen, "Truth in Securities" Revisited,
79 Harv. L. Rev. 1340, 1386 (1966).
-[3]- See Disclosure to Investors, A Reappraisal of
Administrative Policies Under the 1933 and 1934
Acts, Report and Recommendations to the SEC from
the Disclosure Policy Study, at 53 (March 27,
1969) (the "Wheat Report").
==========================================START OF PAGE 5======
duplicative and unnecessary, at least in those instances where
the issuer was widely followed by the analyst community.
Based upon the conclusions of the Wheat Report, as well as
the recommendations of the Commission's Advisory Committee on
Corporate Disclosure published in 1977,-[4]- the Commission
moved to integration of the disclosure requirements of the
Securities Act and the Exchange Act. Under the integrated
disclosure scheme implemented in 1982, seasoned issuers can avoid
providing prospectus disclosure duplicative of company
information that already has been provided in its Exchange Act
reports through incorporation by reference of that information
into the prospectus. Under this approach, critical company-
specific information required under the prospectus disclosure
provisions of the Securities Act is made available to investors
through the public filing of a company's periodic reports, but is
not required to be repeated in the prospectus delivered to
purchasers in the offering. Instead, the short-form prospectus
physically delivered must provide information specific to the
transaction, but generally can refer the investor to the filed
reports for information regarding the seasoned company's
business, management, financial condition and similar matters.
---------FOOTNOTES----------
-[4]- Wheat Report, supra n.3; Report of the Advisory
Committee on Corporate Disclosure to the
Securities and Exchange Commission, 95th Cong.,
1st Sess. (Comm. Print 1977 ) (the "1977 Advisory
Committee Report").
==========================================START OF PAGE 6======
Thus, for more than a decade, with respect to the core
financial and operating information regarding seasoned issuers,
the Commission has deemed the prospectus disclosure objectives of
the Securities Act to be satisfied by reliance on the public
filing of this information and its incorporation by reference
into an offering document, without any physical delivery of such
information to investors. In addition, and as discussed more
fully below, technological innovations are facilitating
inexpensive electronic access to filed documents by the market
and by investors and their intermediaries, thereby raising
further questions regarding the continued need for delivery of
disclosure documents directly to investors in the context of
public offerings.
==========================================START OF PAGE 7======
A. Disclosure and Prospectus Delivery Under the Company
Registration System
Company registration would improve upon the crucial
disclosure goals of the current filing and prospectus
delivery requirements by requiring that mandated
disclosure be made public, or delivered to investors,
at an earlier point in time than under the current
system. So long as all mandated information already
has been publicly disclosed, company registration would
create greater flexibility regarding the prospectus
information to be delivered directly to investors.
Such information would be provided based upon the
issuer's and underwriter's assessment of the
informational demands of the markets and participants
in the offering.-[5]-
1. Company Registration Statement
Under the company registration scheme, to become company-
registered, an eligible company would file a Form C-1
registration statement disclosing its plans to sell securities
from time to time in the indefinite future on a company-
registered basis. The Form C-1 would be kept current by
incorporating all existing and future Exchange Act reports into
the Form C-1. The Form C-1 would contain a generic description
of the type of securities the issuer anticipated issuing, as well
as a general discussion of its financing plans. In essence, the
registration statement would not be a single document, but rather
a composite of the initial Form C-1, all existing and
subsequently filed Exchange Act reports incorporated into that
registration statement, as well as any post-effective amendments
---------FOOTNOTES----------
-[5]- A comparison of the proposed company registration
system and the current short-form shelf
registration system is included in an addendum to
this Appendix B.
==========================================START OF PAGE 8======
thereto. Only a nominal registration fee would be required to be
paid at the time of the Form C-1's filing, accompanied by an
undertaking by the issuer to pay a fee upon each sale of
securities under the Form C-1. This approach would create a
"pay-as-you-go" system.
Once a company is registered, no further registration
process would be necessary to offer securities. To accomplish
that result during the pilot under the current statutory scheme,
the Form C-1 would serve as a registration statement for purposes
of Section 5 of the Securities Act and register generically all
types of securities and offerings (including affiliate resales)
contemplated at the time of the company's registration. The
issuer is given discretion to the extent it wishes to include all
or just some of its securities on the Form C-1, depending on the
degree of participation. Even under full participation in the
system, a registered company may exclude non-convertible debt
sold only to institutional buyers -- but not equity securities
(including equity convertibles) or debt sold to retail buyers --
from the system. With respect to those companies electing to
take full advantage of the system,-[6]- all subsequent sales
of securities by registered companies and their affiliates would
be deemed covered by the Form C-1 registration statement, and
thus would be registered for purposes of the Securities Act. If
the company had outstanding restricted securities at the time it
---------FOOTNOTES----------
-[6]- See infra p. 34-40.
==========================================START OF PAGE 9======
became company-registered, the company could effect a transition
to the company registration system by specifically registering
any or all of its outstanding restricted securities for resale on
the Form C-1 (and paying a fee at that time), or merely allow the
restricted securities to retain their restricted status until the
expiration of the Rule 144 restricted periods.-[7]-
All purchasers of securities from the issuer or its
affiliates, therefore, regardless of the nature of the
transaction, would receive freely tradeable securities, as well
as the benefit of all statutory remedies that now attach to
information disseminated in connection with a registered offering
of securities. Thus, investor protection would be preserved and
extended to a broader class of transactions, while regulatory
concepts that are no longer necessary under a company
registration system to protect investors -- such as gun-jumping
and restricted securities -- would be eliminated.
2. File and Go
Under the company registration system, a registered company
could go to market in most transactions without encountering
regulatory delays. Sales would be permitted immediately upon, or
shortly following, the public filing of mandated disclosure
regarding the transaction and any recent material developments
---------FOOTNOTES----------
-[7]- In the case of privately placed debt securities,
the issuer also would have to execute a qualified
indenture at the time it registers its outstanding
debt to satisfy the requirements of the Trust
Indenture Act, absent an exemption.
==========================================START OF PAGE 10======
concerning the company not previously disclosed in filings, along
with the payment of the fee.
As noted previously, the Committee considered, but
determined not to review specific line-item disclosure
requirements applicable to public offerings in connection with
its development of a company registration scheme. Accordingly,
the transactional information that must be on file at the time of
an offering would be essentially the same as that required
today.-[8]- Transactional information would be required to
be filed at the time of the offering to provide notice of the
transaction, pay the fee and provide other information material
to the transaction to the extent the information was not
previously disclosed in the Form C-1 (including in any post-
effective amendments to, or Exchange Act reports incorporated
---------FOOTNOTES----------
-[8]- Thus, for example, in financings, in addition to
updating its company-related disclosure (to the
extent necessary), the issuer would need to have
on file with the Commission at the time of an
offering the transactional information required by
the following disclosure items under Regulation S-
K, to the extent applicable:
Item 202: Description of the Securities
Item 503: Summary Information, Risk Factors and Ratio of
Earnings to Fixed Charges
Item 504: Use of Proceeds
Item 505: Determination of Offering Price
Item 506: Dilution
Item 507: Selling security holders
Item 508: Plan of distribution
Item 509: Interests of Named Experts and Counsel
Similarly, in the case of business combinations, the
information called for by current Form S-4 would be filed
with the Commission.
==========================================START OF PAGE 11======
into, the Form C-1). As an example, the Form C-1 could describe
the plan of distribution or possible alternative plans of
distribution, and the filing at the time of the transaction need
only disclose which offering technique is being employed.
Similarly, use of proceeds could be generically disclosed in the
Form C-1 and updated as necessary at the time of the transaction.
Summary financial information and pro forma data would only be
required where not previously disclosed and where material to
investors.
In the case of offerings under the company registration
system of equity securities over a de minimis threshold (e.g.,
three percent), the transactional information (which would be, at
a minimum, the fact that the transaction is occurring) would be
required to be filed with the Commission on a Form 8-K no later
than at the time of the transaction. The Committee also
recommends that this Form 8-K filing requirement be applied to
takedowns off the shelf under the current system. The purposes
of this filing, which is not required today for short-form shelf
offerings, is to ensure that this information is disclosed to the
market at the time of the offering, to ensure that it is
incorporated into the registration statement (and thus within the
coverage of Section 11 liability),-[9]- and to provide a
document prepared at the time of the offering that will
facilitate the due diligence inquiries of underwriters and other
---------FOOTNOTES----------
-[9]- See infra pp. 63-64.
==========================================START OF PAGE 12======
gatekeepers or monitors. The Commission may wish to consider
devising some minimal integration period for measuring offerings
against the de minimis threshold (e.g., two or three business
days) to provide clarity as to the filing
requirement.-[10]- Separately, if the issuer's filings
need to be updated with material company developments (except in
a "limited placement, see Section III.E below), the issuer must
disclose those developments in a Form 8-K filed in advance of the
transaction. That filing also could serve as the transactional
Form 8-K filing if the appropriate information is included. If
this material updating information is to be provided to investors
solely by incorporating it by reference into the prospectus (see
next section below), then it will have to be on file a sufficient
amount of time for the market to have absorbed the information
before a sale is made.
In de minimis equity offerings and in all debt offerings
covered by the Form C-1 (see supra p. 5-6), the issuer would have
a choice with respect to the appropriate means to effect the
filing of the requisite transactional and material developments
disclosure. It could include that information in a Form 8-K, as
described above; alternatively, the company could include all of
the required disclosure in the prospectus supplement that is
---------FOOTNOTES----------
-[10]- This prompt filing requirement at the time of sale
may require the Commission to make accommodations
to accept Form 8-K filings with respect to
transactions taking place outside of normal
business hours.
==========================================START OF PAGE 13======
delivered to investors, and simultaneously filed with the
Commission. Consequently, in these de minimis equity offerings
and debt offerings, the company registration model was made
consistent with current practice under shelf registration in that
the prospectus supplement would not be subject to Section 11
liability, because it is not deemed part of the registration
statement,-[11]- except that company registration would
require the prospectus supplement to be filed with the Commission
at an earlier point in time than under the current
system.-[12]-
As noted, the transactional filing at the time of the
offering could disclose any material changes in the registrant's
affairs that have occurred since the latest filing (which could
be a Form 8-K filed shortly before the offering) updating the
company registration statement. Where necessary to avoid
misleading investors, for example, this information would include
an update of the company's MD&A disclosure. Where the updating
---------FOOTNOTES----------
-[11]- See infra p. 63-64.
-[12]- Under current Rule 424(b)(2) [17 C.F.R.
230.424(b)(2)], a prospectus supplement prepared
in connection with a shelf offering must be filed
no later than the second business day following
the earlier of the determination of the offering
price or its first use. Thus, under the current
system, the information in the prospectus
supplement may not be disclosed to the secondary
trading markets for as many as two days after its
dissemination to investors in the offering.
Company registration would accelerate the required
filing of the prospectus supplement by at least
two days since the prospectus supplement would be
required to be filed simultaneously with its use.
==========================================START OF PAGE 14======
information represents a fundamental change in the information
previously disclosed regarding the issuer in Commission filings,
consistent with current requirements for shelf
offerings,-[13]- that information must be provided either
by means of a post-effective amendment or an Exchange Act report
filed in lieu thereof. A prospectus supplement would not suffice
for this purpose.
Thus, the company registration system not only would
maintain the level of information currently required to be
disclosed in Commission filings concerning a particular
transaction, but also would reinforce the existing obligation of
a company offering securities to the market to ensure that its
public disclosures are current and complete in every material
respect,-[14]- and would accelerate the public disclosure
of such information to investors in both the primary and
secondary markets.
3. Prospectus Delivery
The company registration system also would address the need
to disseminate a statutory prospectus to participants in an
offering. A principal goal of the Committee has been to recast
the prospectus from what in many cases is its current function --
a document prepared to comply with regulatory requirements and to
---------FOOTNOTES----------
-[13]- See, e.g., Item 512(a)(1)(ii) of Regulation S-K
[17 C.F.R. 229.512(a)(1)(ii)].
-[14]- See Shaw v. Digital Equipment Corp., 82 F.3d 1194
(1st Cir. 1996).
==========================================START OF PAGE 15======
provide the issuer with a defense in the event of litigation,
which often is not sent to investors until after the investment
decision is made -- into a tool to convey meaningful information
at the time of the investment decision.
The system would continue to require transactional
information to be physically delivered as part of the prospectus
in those circumstances where it may be argued that delivery of
that information might serve to facilitate an investor's
evaluation of the issuer and the security. For example, if the
company is issuing a new security, the company registration
system would require that the terms of the new security, along
with the specific risks of investing in the security, be
delivered to potential investors. However, the company
registration system also would provide the flexibility for
issuers to file the information with the Commission without
physical delivery to investors, where delivery is not necessary
for that purpose and such information already has been disclosed
to the markets through a public filing with the Commission.
More significantly, company registration would allow for the
use of a meaningful summary prospectus, the content of which
would be dictated primarily by the informational demands of
investors, rather than by regulatory mandates and litigation
concerns.-[15]- Since in almost all but the smallest
---------FOOTNOTES----------
-[15]- The AIMR suggested that the Committee recommend
that every offering of securities be accompanied
by an offering circular that would include the key
terms of the offering, but "no boilerplate or
(continued...)
==========================================START OF PAGE 16======
equity offerings the company would be required to file with the
Commission all mandated transactional and updating disclosure
prior to any sales of securities, thereby enhancing investor
protection through the earlier disclosure of this information to
the markets than under the current system, issuers would be
granted the flexibility and the responsibility to decide what
information should physically be delivered to investors. The
Committee expects that the disclosure contained in the prospectus
delivered to investors, whether this prospectus is a document
that resembles a traditional prospectus, selling materials, or
the confirmation of sale, will be that information the issuer
deems most relevant and material to the potential investors.
---------FOOTNOTES----------
-[15]-(...continued)
legalese." See Documents for Advisory Committee
Meeting, September 29, 1995, Tab E (Letter dated
September 27, 1995 from the AIMR to Commissioner
Wallman, at 3). Though not mandated, the
Committee anticipates that the elimination of the
prospectus delivery requirement in routine
transactions will promote the use of such short-
form offering documents. See also John C. Coffee,
Jr., Re-Engineering Corporate Disclosure: The
Coming Debate Over Company Registration, 52 Wash.
& Lee L. Rev. 1143, 1159 (1995) ("Coffee, Re-
engineering Disclosure"), discussing the impact of
shelf registration on the disclosure in
prospectuses:
Of course, the prospectus largely deteriorated
into a legal fiction as a result of [the
transition to shelf registration]. Only the one
or two page summary table at the front of the
typical Form S-3 registration statement is today
coherent to the average investor. Shelf
registration and incorporation by reference really
implied that disclosure to the market through
[Exchange Act] filings replaced disclosure to
individual investors through prospectuses.
==========================================START OF PAGE 17======
Since all mandated disclosure must either be filed with the
Commission or delivered to investors at or prior to any sale of
securities (and must be filed no later than any sale in a non-de
minimis equity offering), the market and all investors will
receive the information at the same time, or at an earlier point
in time than under the current system. In addition, the issuer
and other offering participants will have the same, or greater,
liability for such information, as under the current system. The
fact that all the mandated information is publicly available
allows the issuer to include only the information most useful to
an investor's understanding in the document physically delivered
to investors, presented in a plain-English format that is readily
accessible and understandable by the investor.
The desired flexibility regarding prospectus delivery would
be achieved under the pilot in a manner consistent with current
prospectus delivery requirements of the Securities Act. Under
company registration, issuers would be permitted to use
incorporation by reference in a manner similar to that now
available to seasoned companies to omit core, company-specific
information from the prospectus delivered to investors. Subject
to certain exceptions, a registered company could, but need not,
use incorporation by reference to meet its prospectus delivery
obligation with respect to the mandated transactional information
as well. It can do so by incorporating, rather than physically
delivering, all or portions of that information from any filed
document such as a Form 8-K (whether mandated or filed solely for
==========================================START OF PAGE 18======
this purpose). This incorporation by reference could be into a
document serving as the prospectus that is delivered at the time
of confirmation of sale. Just as they currently have with
respect to material company information, these issuers thus would
have the flexibility to include all, some, or even none of the
transactional information in the prospectus delivered to
investors.
In "routine transactions," the confirmation of sale itself
could serve as the prospectus, so long as it expressly
incorporates the necessary information on file with the
Commission. Broker-dealer firms would satisfy their prospectus
delivery obligations with respect to the distributed securities
and aftermarket transactions in the same fashion.-[16]-
This flexibility in the informational content of the
prospectus to be delivered represents a further extension of
current law. Since the adoption of incorporation by reference,
the Commission has allowed company-related disclosure (which
comprises a large portion of the mandated disclosure in a public
offering) to be incorporated, rather than repeated in full, in
the prospectus without any apparent loss of investor protection.
Permitting transactional information in some instances also to be
incorporated by reference amounts to a further incremental step.
Just as issuers today often include a "recent developments"
---------FOOTNOTES----------
-[16]- See Section 4(3) of the Securities Act [15 U.S.C.
77(e)(3)]; Rules 174 and 434 under the Securities
Act [15 C.F.R. 230.174 and 230.434]; Rule 15c2-8
under the Exchange Act [17 C.F.R. 240.15c2-8].
==========================================START OF PAGE 19======
section in shelf takedown prospectuses, the Committee anticipates
that issuers will continue to use their judgment in including any
transactional information in the prospectus to the extent that
public filing alone of such information might not afford adequate
notice to a potential investor.
The Committee believes that delivery of a prospectus as a
marketing device in equity offerings likely would remain the
common practice under the company registration system. Use of
the prospectus would continue to depend on factors such as the
nature and name recognition of the issuer, the size of the
offering relative to the issuer's public float, the retail or
institutional nature of the targeted investors, the price
expectations of the issuer relative to the current market value
and whether or not the public filing of the disclosure is
effective dissemination to the potential investors. Because
market forces reasonably can be relied upon to ensure the
delivery of the appropriate level of information (at least in the
case of seasoned issuers), a substantial argument could be made
that there is no need to mandate prospectus delivery in any
instance.-[17]-
---------FOOTNOTES----------
-[17]- In other jurisdictions such as Australia that have
eliminated mandated specified line item disclosure
requirements in favor of a general materiality
standard, often prospectuses continue to contain
most, if not all, of the same disclosure as when
specific disclosure requirements were mandated.
See Documents for Advisory Committee Meeting, June
15, 1995, Tab F (Study of Foreign Regulatory
Processes).
==========================================START OF PAGE 20======
The Committee nevertheless concluded that physical delivery
of a formal prospectus containing the transactional information
should be required in certain circumstances. For the purposes of
the pilot, the issuer will be required to deliver (rather than
incorporate) the transactional information as part of the
prospectus in the case of substantial offerings of equity
securities (i.e., "non-routine" transactions). Those offerings,
because of their size, are likely to alter substantially the
information previously provided to the market and to involve
significant oral and written selling efforts.-[18]-
Accordingly, during the pilot, traditional prospectus delivery
would be retained for offerings of voting securities in an amount
in excess of (or potentially representing in excess of, in the
case of warrants and convertible securities) 20 percent of the
---------FOOTNOTES----------
-[18]- The Committee considered a suggestion that the
prospectus delivery requirement be imposed
whenever "special selling efforts" were employed
in the marketing of the offering. See Documents
for Advisory Committee Meeting, July 26, 1995, Tab
E (Letter dated June 27, 1995 from Richard
Phillips to Commissioner Wallman). Special selling
efforts could be evidenced by brokers'
compensation beyond ordinary commissions and fees,
as well as the distribution of selling materials.
Although various members of the Committee agreed
that heightened disclosure and liability should
accompany special selling efforts (see Transcript
of July 26, 1995 Advisory Committee Meeting at
256-57, 260), the Committee was concerned that the
use of these concepts to identify transactions
that require prospectus delivery would perpetuate
existing confusion engendered by the use of that
concept in other contexts under the federal
securities laws, and that a simpler approach of
the type recommended could satisfy the perceived
needs to the same extent. Id. at 260-264.
==========================================START OF PAGE 21======
current market value of the issuer's voting securities held by
non-affiliates. As today under shelf registration, the
prospectus normally would be filed with, but would not be subject
to prior review by, the Commission.-[19]-
After reviewing data on the distribution of recent public
offerings of equity as a percentage of an issuer's outstanding
capital, the Committee chose 20 percent as the minimum delivery
threshold.-[20]- In setting this threshold, the Committee
sought to provide registered companies with flexibility to
conduct a transaction (or series of transactions) that increase a
company's public float by an amount that could be sold into the
market without use of a formal prospectus -- for example, through
regular trading transactions or placements of blocks -- without
preparing a traditional prospectus. In these latter "routine"
transactions, investors least expect the information
traditionally provided in a prospectus to make an investment
decision.-[21]- Rather, absent unique circumstances
---------FOOTNOTES----------
-[19]- The one exception would be extraordinary
transactions in equity securities, exceeding 40
percent of the issuer's existing capital base,
which would require the filing of a post-effective
amendment to the company registration statement
and would be subject to staff review.
-[20]- See Documents for Advisory Committee Meeting,
November 21, 1995, Tab D.
-[21]- See Coffee, Re-engineering Disclosure, supra n.15,
at 1145 (stating Milton Cohen's view that
"[b]ecause the [Exchange] Act creates a system of
continuous, periodic disclosure, the existence of
this system profoundly reduces the need for
transaction-specific disclosure at the time when
(continued...)
==========================================START OF PAGE 22======
regarding the transaction, investors will tend to focus on the
company-related disclosure already disseminated to the market and
reflected in the company's stock price. In other words,
consistent with the guideline articulated by Milton Cohen, the
appropriate delivery threshold would allow those transactions
that today involve delivery of a prospectus only at the time of
the confirmation, and not as part of the marketing process, to
proceed without any formal delivery of a prospectus.-[22]-
Conversely, where transactional disclosure is required to be
delivered in a prospectus, the Committee feels strongly that it
should be delivered to investors in sufficient time to influence
and inform their investment decision. The Committee therefore
determined that any prospectus required to be delivered in these
substantial equity offerings should be delivered prior to the
time the investor determines to purchase.-[23]-
---------FOOTNOTES----------
-[21]-(...continued)
an issuer later seeks to sell its securities.
Logically, a corporate issuer seeking to sell
securities under a continuous disclosure system
would only be required to disclose any additional
material information that it had not previously
disclosed pursuant to the continuous disclosure
system.")
-[22]- Cohen, supra n.2, at 1386; see also Linda C.
Quinn, Reforming the Securities Act of 1933 - A
Conceptual Framework, INSIGHTS at 25 (January
1996) (the "Quinn Speech").
-[23]- Cf. Rule 15c2-8 under the Exchange Act [17 C.F.R.
240.15c2-8] (prospectus required to be delivered
48 hours prior to sending the confirmation of sale
in IPOs which may still be after the investor
agrees to the sale). The Committee recognizes
that the prospectus delivered at the time of sale
(continued...)
==========================================START OF PAGE 23======
Because of the Committee's belief that it should be
investors' informational needs that dictate the need for a
prospectus as a selling document and the content of that
prospectus,-[24]- and that the elimination of regulatory
mandates with respect to seasoned issuers would not result in
less useful information being provided to investors, the
Committee was comfortable in establishing a generous threshold in
order to preserve maximum issuer flexibility.-[25]-
Nevertheless, the determination of the appropriate threshold is
best made with the benefit of the comment process that
---------FOOTNOTES----------
-[23]-(...continued)
in these non-routine transactions will resemble
preliminary prospectuses (i.e., "red herring") in
that price-related and other current information
normally would have to be omitted and provided on
a supplemental basis. That information would
otherwise be available, in any event, through the
filing of the transactional Form 8-K at the time
of sale.
-[24]- The Committee has been informed on an anecdotal
basis that disclosure documents in Rule 144A
placements closely resemble prospectuses in
registered offerings, even though there are no
Commission-specified disclosure requirements in a
Rule 144A placement other than under a general
antifraud standard.
-[25]- Based upon data reflecting market capitalization,
rather than public float, approximately 68 percent
of underwritten repeat offerings of common stock
in 1992-1994 would fall below the 20 percent
recommended threshold for mandatory prospectus
delivery. Thus, prospectus delivery would not
have been required in over two-thirds of such
offerings. If the threshold were lowered to 10
percent, prospectus delivery would have been
eliminated for only 30 percent of such
transactions. See Figure 6 in the Addendum to
Appendix A of the Report.
==========================================START OF PAGE 24======
accompanies Commission rulemaking proceedings, and could be
significantly lower or greater than 20 percent-[26]- and
involve factors other than a percentage of the public
float.-[27]- Indeed, this threshold could be increased and
combined with the extraordinary transaction tier with resulting
simplification of the system. While not formally recommended for
the pilot, the Commission may wish to consider whether similar
thresholds should be developed for offerings of senior non-voting
equity securities as well as non-investment grade debt.
Where required to deliver a prospectus, the issuer still
would be permitted to take advantage of incorporation by
reference of company information to the same extent as permitted
today, and still would be allowed to include any additional
information it deems material in the prospectus. Similarly,
delivery of the statutory prospectus could be accomplished in the
same manner as permitted today, provided the prospectus was
---------FOOTNOTES----------
-[26]- In France, Germany and the United Kingdom, no
prospectus is required if the offering is for less
than 10 percent of an existing class listed on an
exchange and certain other conditions are met.
See Documents for Advisory Committee Meeting, June
15, 1995, Tab F (Study of Foreign Regulatory
Processes).
-[27]- See, e.g., Exchange Act Rel. 37094 (April 11,
1996) [61 FR 17108 (April 18, 1996)] (proposing
use of Average Daily Trading Volume as basis for
applicability of proposed Regulation M). See also
NYSE Listed Company Manual, 312(c)(i) (July
1989).
==========================================START OF PAGE 25======
received in time to influence the investment
decision.-[28]- Thus, in these circumstances, the
prospectus would be expected to contain, at a minimum, the same
level of information found in a prospectus used today by a
seasoned issuer in an offering conducted on Form S-3. Other
circumstances in which physical delivery of transactional
information, rather than incorporation by reference, would be
necessary, include:
Information Necessary To Avoid Misleading Investors
Just as, and to the same extent as, under the current
shelf system, reliance on incorporation by reference
into the prospectus or selling materials would not be
appropriate where statements appearing in the
physically delivered materials would be rendered
misleading by the absence of information appearing only
in filed documents.-[29]- Similarly,
incorporation by reference of material developments
that have not been disclosed sufficiently in advance of
the use of the prospectus to allow the market to access
and absorb the information would not be appropriate.
Use of Selling Materials Under the current system, to
the extent written selling materials that do not
satisfy prospectus disclosure requirements are
distributed to investors in the course of the offering,
a prospectus containing the mandated information has to
be delivered prior to or simultaneous with the
materials.-[30]- Under company registration, an
---------FOOTNOTES----------
-[28]- See, e.g., Rules 430A and 434 under the Securities
Act [17 C.F.R. 230.430A and 230.434].
-[29]- See Proposed Revision of Regulation S-K and Guides
for the Preparation and Filing of Registration
Statements and Reports, Securities Act Rel. 6276
(December 23, 1980) [46 FR 79 (January 2, 1981)] .
-[30]- Section 5(b) of the Securities Act [15 U.S.C.
77e(b)] prohibits the use of any prospectus to
sell a security even after the registration
statement is declared effective, unless the
prospectus contains all the information mandated
(continued...)
==========================================START OF PAGE 26======
issuer could avoid delivery of two different documents
by either including or incorporating by reference the
required information into the selling materials and
treating the selling materials as the statutory
prospectus. That approach would require the materials
to be filed and subject them to liability under Section
12(a)(2) of the Securities Act (whereas generally such
documents are subject only to fraud liability under the
current system).
The Committee recommends that, after a period of time, the
Commission revisit the circumstances under which physical
prospectus delivery requirements should be retained.-[31]-
Under the current system, prospectuses frequently are not
provided to investors until after an investment decision is made,
do not carry the appropriate level of liability, and do not
inform the market at an appropriate time. Under company
registration, these issues are resolved through enhanced and
---------FOOTNOTES----------
-[30]-(...continued)
by the Act and Commission rules. Selling
materials are excluded from the definition of
prospectus under Section 2(10) of the Act [15
U.S.C. 77b(10)] only if their delivery is
accompanied or preceded by a statutory prospectus.
-[31]- The Commission views delivery through electronic
means as satisfying the delivery or transmission
requirements of the federal securities laws if
such distribution results in the delivery to the
intended recipients of the required information --
the means are not relevant. See Use of Electronic
Media for Delivery Purposes, Securities Act Rel.
7233 (October 6, 1995) [60 FR 53458 (October 13,
1995)]; see also Use of Electronic Media by
Broker-Dealers, Transfer Agents, and Investment
Advisers for Delivery of Information; Additional
Examples Under the Securities Act of 1933,
Securities Exchange Act of 1934, and Investment
Company Act of 1940, Securities Act Rel. 7288 (May
9, 1996) [61 FR 24644 (May 15, 1996)].
==========================================START OF PAGE 27======
accelerated transactional filing requirements. Consequently, it
may be possible to dispense with a physical prospectus delivery
requirement in all but extraordinary circumstances.-[32]-
For the present, however, the Committee was not prepared to
conclude that delivery of prospectus information to the market at
large through filed documents is an adequate substitute for
physical delivery to all investors in all cases, and thus
determined to recommend that delivery of a traditional prospectus
still be required to be made to non-accredited investors in non-
routine transactions. The Committee was concerned that
individual investors may not have access to alternative
information sources for obtaining information on file with the
---------FOOTNOTES----------
-[32]- A number of countries do not require that the
prospectus be delivered to offerees and purchasers
other than by publication. France, Germany and
the United Kingdom call for either the publication
of the prospectus, with investors offered an
opportunity to request additional information, or
merely the publication of the availability of the
prospectus, including specification of the place
where investors may go to obtain a prospectus. In
addition, subject to certain conditions, in
Germany and the United Kingdom, for repeat
offerings of less than 10 percent of the market
capital of a previously listed security, the
prospectus requirement has been eliminated. If
such securities also are to be listed, the
relevant exchange still must approve the
additional listing application, but no disclosure
document is required as part of the applications
process. However, the United Kingdom does require
publication of the number and type of securities
to be listed as well as the circumstances of their
issuance. France has a similar exemption, but
imposes far more conditions on its use. See
Documents for Advisory Committee Meeting, June 15,
1995, Tab F (Study of Foreign Regulatory
Processes).
==========================================START OF PAGE 28======
Commission, even if access to such filed information is provided
earlier via these sources than the more traditional means used
under the current system.-[33]- In all instances, physical
prospectus delivery would not be required to be made to
accredited investors. Such investors would benefit under company
registration from access to information required to be filed with
the Commission earlier than it is now required to be provided to
any investor under the current Form S-3 primary shelf offering
process. Moreover, such accredited investors are in a position
to have such information delivered directly to them if they so
prefer.
---------FOOTNOTES----------
-[33]- See Transcript of May 8, 1995 Advisory Committee
Meeting at 233-236.
==========================================START OF PAGE 29======
B. Role of the Commission and Other Gatekeepers or
Monitors
Outside gatekeepers -- the regulators, lawyers,
underwriters, accountants and other professionals --
are critical to the integrity of the securities
markets. Current offering procedures allow an issuer
to market securities with little notice and without
adequate opportunity for meaningful review and
investigation at the time of the offering by the
traditional gatekeepers. The Committee thus explored
means to enhance their roles. Company registration
will facilitate the due diligence process by reordering
and rationalizing the gatekeeping functions in a manner
that will improve their effectiveness in ensuring the
dissemination of quality disclosure to the market, not
only in connection with public offerings, but on a
continuous basis as well. Company registration would
make the necessary adjustments to this traditional
function by encouraging ongoing monitoring of the
issuer's disclosures by the parties in the best
position to perform that function.
1. The Commission Review Process
As noted, neither the Form C-1 nor the transactional
disclosure filed with the Commission and publicly disseminated at
the time of the offering normally would be subject to staff
review prior to the commencement of the offering. This approach
would not reflect a significant change in current Commission
administrative practice. The Commission already has shifted a
significant part of its gatekeeping function to reviewing company
related and financial information in Exchange Act reports,
although a public offering remains a selection factor even for
seasoned issuers. As reported in Table 2 to Appendix B, only
approximately 16 percent of filings by seasoned issuers on Form
==========================================START OF PAGE 30======
S-3 are reviewed by the staff.-[34]- With regard to
securities sold off an already effective shelf registration
statement, prospectus supplements disseminated upon takedown are
never subject to staff pre-review.
Some have argued that the mere possibility that an offering
could be selected for review remains an important deterrent to
inadequate or misleading disclosure practices. The Committee
concluded, however, that this deterrent effect comes at the cost
of significant uncertainty in the timing of securities offerings
that often lead even seasoned issuers to resort to alternative
capital-raising techniques that generally offer less investor
protection. Even with the adoption of the universal shelf
system, issuers still are drawn to alternative markets. This is
apparently due in part to issuer demand for immediate access to
the market, which could be delayed by the potential review of the
Form S-3 shelf registration statement.
In the Committee's view, the significant deterrent to the
sale of securities with less than complete and accurate
information would be preserved for these seasoned issuers through
Commission staff review of transactional documents at the time it
reviews the company's Exchange Act reports, just as is currently
---------FOOTNOTES----------
-[34]- In FY 1995, of the 3900 reporting companies
reviewed, two-thirds were reviewed in an Exchange
Act, rather than transactional, context. Of the
reporting issuer reviews in a transactional
context, approximately half included a review of
the registrant's Exchange Act reports. See Quinn
Speech, supra n.22, at 30 n.21.
==========================================START OF PAGE 31======
the practice regarding takedown prospectuses for offerings of
securities off already effective shelf registration statements.
As with the current system, the presence of significant financing
or acquisition activity should remain a factor considered by the
Commission staff in determining whether to select an issuer for
review. The prospect that the Commission staff could issue
significant comments and insist on material revisions to
disclosures already relied upon in connection with an offering of
securities (a possibility that also exists today) should provide
adequate incentive to ensure that the company's disclosure is of
the highest quality.
The Committee nevertheless determined, at least for purposes
of the pilot, that extraordinary distributions of equity
securities by registered companies should remain potentially
subject to staff pre-review. Offerings of voting securities
exceeding 40 percent of the existing public float should be
required to be filed on an amendment to the Form C-1 registration
statement that would not become effective absent acceleration by
the staff. In addition, the likelihood of staff review of proxy
materials in connection with extraordinary transactions will
continue to ensure that transactional reviews take place in those
cases where investor rights are most likely to be
affected.-[35]- For this reason, the Committee considered
---------FOOTNOTES----------
-[35]- The New York Stock Exchange requires, as part of
its listing requirements, shareholder approval for
the issuance of stock with voting power equal to
or in excess of 20 percent of the voting power
(continued...)
==========================================START OF PAGE 32======
limiting staff pre-review to mergers, acquisitions, and other
types of restructurings, but not straight financings. However,
the Committee determined that such a distinction would be
difficult to administer. Moreover, significant financings can
cause a fundamental change in the nature of the company depending
on the use of proceeds and, at the extreme, could resemble an
initial public offering by a new enterprise. If other criteria
exist for identifying circumstances where staff review of a
transaction may be particularly beneficial to investors (for
example, offerings by distressed issuers), yet afford issuers
predictability regarding whether the filing will be reviewed,
they should be explored.
There remains a concern that an issuer planning an offering
under the company registration system will discover during the
planning process that the staff has selected its Exchange Act
filings for review. The issuer then would have to determine
whether to delay the offering, and thus risk the closing of a
market window, or go to market with the risk that the staff may
have significant comments that may require revisions to existing
disclosure or additional disclosure. Issuers face this dilemma
today in deciding whether to proceed with a shelf offering after
learning that the staff has commenced a review of its Exchange
Act filings. To address this concern in part, the Committee
---------FOOTNOTES----------
-[35]-(...continued)
outstanding, in other than public offerings for
cash. NYSE Listed Company Manual, 312.03(c)(i)
(July 1989).
==========================================START OF PAGE 33======
believes that the Commission could establish a procedure under
which issuers could seek a review, possibly on a nonpublic basis,
when planning to go to market.-[36]- By requesting a
review prior to the offering, registered companies would benefit
by minimizing the chance that the staff would select their
filings for review on the eve of a planned offering. Such a
procedure may be particularly useful where a transaction poses
novel disclosure and accounting issues.
2. The Underwriter
The Committee was advised of the concerns of the
underwriting community that the adoption of a company
registration scheme -- and the wider use of the shelf
registration system, particularly for equity and non-investment
grade debt -- could further erode their ability to conduct
effective due diligence. Consideration was given to what
measures, if any, are necessary to ensure ample opportunity for
underwriter due diligence. These measures could serve either as
a "speed bump" to ensure that underwriters are engaged early
enough in the offering process to provide an adequate opportunity
to review the issuer's disclosures or as a "focal point" to
---------FOOTNOTES----------
-[36]- This process could be similar to that afforded
confidential merger proxies, as well as Securities
Act filings of foreign issuers when necessary to
preserve the confidentiality of a transaction
prior to the marketing of the offer consistent
with home country practice. See Exchange Act Rule
14a-6(e)(2) [17 C.F.R. 240.14a-6(e)(2)]. See
also Transcript of June 15, 1995 Advisory
Committee Meeting at 39 (statement of Edward
Greene).
==========================================START OF PAGE 34======
concentrate attention on due diligence responsibilities. One
suggestion required the issuer to hire or select the underwriters
eligible to participate in the offering at least three days prior
to the offering in the case of underwritten offerings of more
than 10 percent of the issuer's voting securities.-[37]-
The Committee concluded that this suggestion would impose an
artificial burden on the offering process, and that the parties
are in a best position to determine the amount of time necessary
to conduct adequate due diligence. Consequently, the Committee
rejected the notion of a "speed bump" that artificially disrupts
the process.
The Committee was informed by underwriters that the
requirement to file a Form
8-K at the time of the offering containing the transactional
disclosure and any material company-related updating disclosure
in connection with equity takedowns in excess of a certain
percentage of the equity outstanding would help to "focus" the
due diligence inquiries by underwriters. This requirement also
would ensure that the market is informed of both the offering and
of the transactional and material updating information, and that
such information is subjected to the liability provisions of
---------FOOTNOTES----------
-[37]- In his 1985 article, Milton Cohen proposed to
address this question by imposing a waiting period
of at least five days, at least in equity
offerings if not all offerings, unless the
underwriter joins in a request for acceleration of
that period. Milton H. Cohen, The Integrated
Disclosure System -- Unfinished Business, 40 Bus.
Law. 987, 994 (1985)("Cohen, Unfinished
Business").
==========================================START OF PAGE 35======
Securities Act Sections 11 and 12(a)(2). For these reasons, the
Committee recommends this type of Form 8-K filing for both
company registration and shelf registration equity offerings of a
non-de minimis amount.
Moreover, the separate recommendations that information
regarding material developments either be delivered in a
prospectus or be on file prior to its incorporation by reference
into the prospectus, as well as the proposal to deliver the
prospectus prior to sale in the case of substantial equity
offerings, should provide the underwriter with sufficient
additional time to investigate the disclosures.
Finally, the proposed guidance regarding due diligence
practices (discussed in greater detail below) likewise should
create incentives for issuers and underwriters to adopt
disclosure practices that involve the parties best able to ensure
the accuracy of the disclosures in the due diligence process.
The proposed guidance should assist the underwriter in performing
due diligence by identifying the parties to whom the underwriter
can turn with inquiries regarding specific aspects of the
issuer's disclosure.
3. The Auditor
Under the company registration system, just as under today's
shelf registration system, an auditor's consent to the use of its
report, dated as of, or shortly before, the effective date of the
registration statement (as updated by the filing of audited
financial statements on Form 10-K) would have to be on file with
==========================================START OF PAGE 36======
the Commission at the time of the offering.-[38]-
Consistent with current practice with respect to the shelf, the
auditor could consent to incorporation of its audit report into
the company registration statement at the time the Form 10-K
containing the auditor's report is filed. That consent, unless
withdrawn by the auditor, would be applicable to all offerings
pursuant to the Form C-1 until the issuance of a new set of
audited financial statements, or other filings are made that have
the effect of resetting the effective date of the registration
statement. Alternatively, the auditor could determine that its
consent could be filed and currently dated for each specific
issuance of securities, or conditions could be attached to its
use, all as permitted under current practice.
Consideration was given whether to mandate further auditor
review of the Form
10-Q's interim financial statements at the time of their filing,
rather than as part of the annual audit. A special committee of
the AICPA recently called for greater association by independent
accounting firms with the non-audited information of their
corporate clients as a means to enhance the value of business
---------FOOTNOTES----------
-[38]- Auditors generally may not provide "prospective
consents," or consents that are provided
significantly in advance of the effective date of
the registration statement. Under Section
11(b)(3)(B) of the Securities Act, the adequacy of
an auditor's due diligence inquiry will be judged
"at the time such part of the registration
statement became effective . . . ." [15 U.S.C.
77k(b)(3)(B)].
==========================================START OF PAGE 37======
reporting to end-users.-[39]- Many seasoned public
companies now engage their outside auditors to perform a review
of interim financial information in accordance with Statement on
Auditing Standards ("SAS") No. 71.-[40]- Pursuant to this
standard, an independent accounting firm will make inquiry
regarding the company's internal control structure and any
significant changes therein since the most recent financial
statement audit or interim review to determine the possible
impact on the preparation of interim financial information, and
will apply analytical procedures to such information to "provide
a basis for inquiry about relationships and individual items that
appear to be unusual."-[41]-
For purposes of the pilot, the Committee did not believe it
necessary to mandate use of SAS No. 71 reviews by registered
companies. First, there already appears to be growing use of SAS
---------FOOTNOTES----------
-[39]- See generally Improving Business Reporting - A
Customer Focus: Meeting the Needs of Investors and
Creditors, Comprehensive Report of the Special
Committee on Financial Reporting, American
Institute of Certified Public Investors (1994)
(the "Jenkins Committee Report").
-[40]- The Committee was informed that at least one major
accounting firm requires a review of interim
financial information as a condition to their
accepting a SEC audit client. See Transcript of
September 29, 1995 Advisory Committee Meeting at
192 (statements of Mr. Elliott).
-[41]- SAS No. 71.13. Rule 436 under the Securities Act
states that an independent accountant will not be
deemed to have "expertized" a report on unaudited
interim financial information [17 C.F.R.
230.436(c)].
==========================================START OF PAGE 38======
No. 71 reviews by seasoned issuers.-[42]- Moreover, for
larger, more seasoned companies, auditors do not visit the
company just once or even four times a year, but rather can be
there "virtually continuously."-[43]- By clarifying that
SAS No. 71 reviews and any other more detailed reviews of interim
information are appropriate factors to be considered in
determining the proper scope of underwriter and outside director
due diligence, the Committee anticipates that there will be
adequate incentives to adopt the practice.-[44]- As a
---------FOOTNOTES----------
-[42]- A recent survey of approximately 25 percent of the
firm's SEC clients conducted by Price Waterhouse
revealed that "most large companies -- i.e., those
which would initially be eligible for the company
registration process -- already have some kind of
auditor involvement with their quarterly data."
Letter from Arthur Siegel, Price Waterhouse LLP,
to Steven M.H. Wallman, Securities and Exchange
Commission, dated July 3, 1996 (the "Price
Waterhouse Survey").
-[43]- Transcript of September 29, 1995 Advisory
Committee Meeting at 192 (statements of Mr.
Elliott).
-[44]- In debating whether any form of review of interim
financials, or even non-financial information, by
auditors should be mandated as a condition of
opting into the company registration system, the
Committee was concerned about imposing undue
burdens on issuers in the form of additional
costs. In 1989, the Commission considered, among
other matters, revising its rules to require
interim financial information of registrants be
reviewed by independent auditors before such
information was filed with the Commission, and
requested public comment on both the perceived
need for such revisions and any incremental costs
and benefits of imposing such requirement. In a
comment letter from Arthur Andersen & Co., the
firm estimated that the incremental cost of
mandating timely interim reviews to a majority of
(continued...)
==========================================START OF PAGE 39======
result, the auditor's gatekeeping function would be enhanced by
causing its reviews of interim financial information to occur on
a more current basis when corrections can be made in filed
reports before they are disseminated to the public, rather than
after the close of the fiscal year.-[45]-
---------FOOTNOTES----------
-[44]-(...continued)
its clients who already had some form of timely
review performed was in the range of 5-20 percent.
For those clients that did not already have a
timely review performed, incremental costs may be
higher. The larger the client, the lower the
incremental cost in percentage terms. In
addition, Arthur Andersen stated that,
notwithstanding the burden of additional cost, the
benefits of mandating such reviews on smaller
companies would be proportionately greater because
of their generally less sophisticated accounting
systems. In Arthur Andersen's view, while the
performance of interim reviews "would not detect
reporting problems to the same extent of an audit,
... it would enhance the overall quality of
smaller registrants' financial information and
reduce the possibility of the issuance of
misleading interim reports." Letter from Richard
Dieter, Arthur Andersen & Co., to Jonathan G.
Katz, Secretary, Securities and Exchange
Commission, dated September 12, 1989.
A more recent survey conducted by Price Waterhouse estimated
that, for those clients for which full, timely SAS 71
reviews are not currently conducted, the average cost per
quarter increase in annual audit fees if such reviews were
to be conducted was
2-7 percent of annual audit fees, assuming a report is
issued only to management and the board of directors. The
average cost would increase to the extent the report was
issued to underwriters or shareholders. Price Waterhouse
Survey, supra n.42.
-[45]- See Transcript of September 29, 1995 Advisory
Committee Meeting at 193 (statements of then SEC
General Counsel Simon Lorne).
==========================================START OF PAGE 40======
The auditor also can serve an important function at the time
of the offering. In many cases, the underwriter or its counsel
will discuss the issuer's financial statements with the issuer's
outside auditing firm, and will request comfort from that firm
with respect to financial information contained in the
prospectus. Since mid-1993, the accounting profession has
followed the guidance prescribed in SAS No. 72 in this context.
An SAS No. 72 engagement relating to a registered public offering
may encompass either or both the audited financial statements and
unaudited financial data set forth in the prospectus. The
auditor may provide positive assurance on compliance with
applicable Commission rules and regulations (such as Regulations
S-X or S-K) as to financial statements and schedules that the
accountant itself has audited.
Finally, an auditor can perform an additional gatekeeping
function at the time of the offering when asked to furnish or
update a consent to the use of his or her report. Prior to
providing such a consent, an auditor makes inquiries and performs
other procedures under SAS No. 37 to satisfy itself that events
subsequent to the date of the annual audited financial statements
do not indicate that adjustments to those statements are
necessary.
II. Company Eligibility
When fully implemented, the benefits of company
registration would be extended to virtually all public
companies that previously had conducted a public
offering of their securities. The concepts of company
registration, however, will be tested under a pilot
open only to certain seasoned companies. The exact
==========================================START OF PAGE 41======
criteria for participation in the system and what, if
any, additional conditions would be necessary for
smaller issuers, will be determined based on experience
with the pilot.
The Advisory Committee considered several approaches for
defining which companies would be eligible for company
registration. The Committee's goal was to extend the benefits of
company registration to as many companies as possible, yet
preserve the current scheme in those instances where it has
proven cost-effective and beneficial to investors. For the
reasons outlined below, for the purposes of the pilot, the
Committee ultimately settled upon the following eligibility
requirements: completion of an initial public offering, a two-
year reporting history, $75 million public float, and a class of
securities listed on the New York Stock Exchange, the American
Stock Exchange, or the Nasdaq-NMS stock market.
The Committee believed that the current process for initial
public offerings ("IPOs") generally works well in assisting a
company in the transition from a private to a public company.
Although in many respects there may be ways to lower the
transaction costs and delays inherent in the "going-public"
process, the Committee determined that those issues should be
addressed separately from the consideration of a company
registration process.-[46]- In the Committee's view, the
---------FOOTNOTES----------
-[46]- An example of such a measure would be the
Commission's current proposal to allow issuers to
"test the waters" in connection with an IPO. See
Solicitations of Interest Prior to an Initial
Public Offering, Securities Act Rel. 7188 (June
(continued...)
==========================================START OF PAGE 42======
current filing and staff review process is instrumental in
assisting the private company to acquaint itself with the
disclosure obligations of a publicly owned company. The delay
inherent in the process allows the company's advisers to help its
management put its books and records in order (including
obtaining audited financial statements) and resolve any insider
transactions or arrangements that may be inappropriate for a
public company. In the Committee's view, there is no alternative
to full due diligence by all outside advisers and gatekeepers in
the context of an IPO.
For these purposes, the Committee recommended that an IPO be
defined as the first registered offering of securities by an
issuer.-[47]- Thus, even a company that has been subject
to reporting requirements for a period of time because its equity
is held by more than 500 record holders and it has more than $10
million in assets,-[48]- or it has securities listed on an
exchange,-[49]- would not be eligible for company
registration until it has made at least one registered offering
---------FOOTNOTES----------
-[46]-(...continued)
27, 1995) [60 FR 35648 (July 10, 1995)].
-[47]- A registered offering by a company that previously
had conducted registered offerings and had been a
reporting company, but thereafter went private and
ceased reporting, would be considered an IPO for
these purposes.
-[48]- Section 12(g) of the Exchange Act [15 U.S.C.
78l(g)] and Rule 12g-1 [17 C.F.R. 240.12g-1].
-[49]- Section 12(b) of the Exchange Act [15 U.S.C.
78l(b)].
==========================================START OF PAGE 43======
of securities under the Securities Act. While a company filing a
Form 10 under the Exchange Act to register a class of securities
is subject to substantially the same disclosure requirements as a
Securities Act registrant, and a Form 10 normally is selected for
staff review, the level of professional outside involvement and
due diligence may be significantly less absent an offering of
securities and the potential application of the strict liability
provisions of Section 11 of the Securities Act.
During the pilot, and perhaps in the initial stages of full
implementation, the company registration system would be
voluntary; eligible companies could opt in as they desired. Once
this election is made, a company could opt out by withdrawing its
registration, but it would not be eligible to use the system
again for a specified period of time (two years is recommended).
This voluntary approach offers the benefit of providing a market
test for the system.
Once experience is gained with company registration, the
benefits of company registration should be made available to
virtually all publicly traded companies to conduct repeat
offerings. One of the advantages of the company registration
system is that, by virtue of the integral enhancements to the
disclosure process, the system will allow the extension of
streamlined access to the capital markets to companies currently
not eligible to use shelf registration. Under the universal
shelf registration process, large companies currently have
significant flexibility. Thus, if eligibility for company
==========================================START OF PAGE 44======
registration were limited to large companies, the benefit for
issuers aided by the system would not be as great as if the
system were extended to other issuers. The Committee recognizes,
however, that extension of the system beyond S-3 eligible issuers
may require additional disclosure enhancements or conditions,
depending upon the experience with the pilot. For example, any
smaller companies permitted to take advantage of the company
registration process that have little market following and
therefore a less efficient market for their securities might be
required to continue to comply with traditional prospectus
delivery requirements for all public offerings regardless of the
amount offered, or to undergo staff review of audited financial
statements prior to their use.
Those determinations necessarily can be made only by the
Commission on the basis of experience gained under the pilot.
For that reason, the Committee concluded that the system should
be phased in gradually, starting with the pilot under which only
larger, more seasoned companies would be eligible to participate.
In this manner, the system could be tested and fine-tuned with
the help of those companies most experienced with the disclosure
responsibilities of public companies and with access to the most
experienced counsel and underwriters.
Initially, the Committee considered using for pilot
eligibility the existing standards established by the Commission
==========================================START OF PAGE 45======
for eligibility to register securities on Form S-3.-[50]-
The Committee concluded, however, that additional criteria would
be useful at the pilot stage. Because the company registration
system would place greater reliance on the quality of the
issuer's Exchange Act reports, the Committee determined that only
companies with a reporting experience of at least two years would
be eligible for participation in the system. In the view of the
Committee, it often takes at least two years following an IPO for
a company and its management to become fully comfortable with the
disclosure obligations of a public company and to have all their
mechanisms for gathering and disseminating information in place
and properly functioning.-[51]-
The Committee also concluded that initial pilot eligibility
should be limited to companies listed on the New York Stock
Exchange or The American Stock Exchange, or quoted in the
National Market System of the Nasdaq Stock Market. Limiting the
eligibility to listed companies has the benefit of adding the
overlay of listing standards, including the agreement to provide
---------FOOTNOTES----------
-[50]- Eligibility for the shelf is generally limited to
companies eligible to register securities on the
Form S-3 short form registration statement. S-3
companies generally include only those that have a
$75 million public float; one-year reporting
history; and are current with respect to their
reporting requirements and certain fixed
obligations. With respect to equity, the public
float requirement is eliminated for secondary
offerings.
-[51]- Transcript of September 29, 1995 Advisory
Committee Meeting at 13-18.
==========================================START OF PAGE 46======
prompt disclosure to the markets of material developments. Such
a criterion is useful at the pilot stage, because it would
minimize the amount of coordination with the states needed
because of the common exemption under state "Blue Sky" laws for
listed companies. After incorporating each of these criteria,
based upon information available to the Committee staff, roughly
30 percent of all reporting companies should qualify for the
pilot.-[52]-
To be eligible, a company must adopt the enhanced disclosure
practices discussed below. During the pilot, noncompliance with
the issuer eligibility conditions or any of the disclosure
enhancements as of the time the issuer's Annual Report on Form
10-K update is filed would result in loss of eligibility to make
offerings pursuant to the company registration form. Similarly,
the issuer must be current with respect to its Exchange Act
reporting obligations at the time of the offering. Voluntary or
involuntary withdrawal from the system would render the issuer
---------FOOTNOTES----------
-[52]- The Committee had considered whether eligibility
should be limited to a senior class of S-3
companies that have a public float of $150 million
(the threshold used prior to 1992), rather than
$75 million. Based upon data available to the
Committee staff, this increase over the S-3
standard would reduce by one-third the percentage
of reporting companies eligible for the system as
compared to the S-3 standard. Because the $150
million level of capitalization may prevent a fair
test for extending the system beyond S-3 eligible
issuers, the Committee determined to retain the
$75 million eligibility standard.
==========================================START OF PAGE 47======
ineligible to elect back into the system for a period of two
years.
Consideration also was given to whether the degree of
research coverage by independent analysts should be an
eligibility criterion. This criterion is not recommended by the
Committee in light of concerns with defining what constitutes
"research coverage." Several commenters also suggested that
eligibility be limited to companies with an investment grade
rating for senior securities. Because many companies do not
obtain ratings, or do so only on the basis of credit
enhancements, and may have different ratings for different
classes of senior securities, this factor was not believed to be
a useful determinant of the quality of the issuer's disclosures
or otherwise consistent with the concept of company registration.
Further, consideration was given to whether eligibility
should be extended to closed-end investment companies.
Registered investment companies are subject to a different set of
reporting requirements under the Investment Company Act of 1940
and the rules and forms adopted thereunder. In the Committee's
view, the company registration system may not be that useful for
these companies. Accordingly, at least for the purposes of the
pilot, the Committee did not recommend inclusion of closed-end
funds, but left the issue to the Commission for any further
review it deemed necessary.
==========================================START OF PAGE 48======
For similar reasons, foreign private issuers generally would
be eligible for the pilot if they file the same forms and meet
the same disclosure requirements as domestic companies. Since
many foreign regulatory schemes do not require the filing of
quarterly reports and any required semi-annual reports generally
are based upon home country disclosure rules and
practices,-[53]- it is possible that participation by these
companies in the pilot may not be appropriate absent their
providing disclosure comparable to domestic companies.
Nevertheless, the Committee urges the Commission to consider
whether a practice analogous to the current practice of some
foreign issuers using the shelf on Form F-3 to provide reconciled
interim financials on Form 6-K on a semi-annual basis, and
incorporating those financials into the shelf registration
statement, would suffice for company registration.
---------FOOTNOTES----------
-[53]- Under the foreign integrated disclosure system,
reporting foreign private issuers file an annual
report on Form 20-F. All other interim financial
information required to be made public under home-
country law is based upon home-country disclosure
rules and practices. Consequently, foreign
private issuers are not required to file quarterly
financials on Form 10-Q or current reports on Form
8-K in accordance with U.S. disclosure
requirements. See Exchange Act Rule 13a-16 [17
C.F.R. 240.13a-16].
==========================================START OF PAGE 49======
III. Transactions Covered
All sales of securities by a registered company will be
afforded the same legal status as a registered offering
of securities under the current scheme, thereby
eliminating or greatly reducing the need for resale
restrictions and other artificial restraints, such as
those necessitated by the concepts of gun-jumping,
restricted securities, affiliate sales, integration of
offers, general solicitation, and flowback of offshore
offerings. Under the voluntary pilot, companies would
be provided the choice of obtaining these benefits by
treating all offers and sales as covered by the company
registration statement, or choosing to preserve the
option to engage in exempt transactions at the cost of
continued regulatory restrictions on resales.
A. Affiliate and Underwriter Resales
With limited exceptions, the company registration system
would be available for all offerings of any securities by
eligible companies. Similarly, sales by affiliates and by any
person acting for a registered company or its affiliates would be
covered by the Form C-1. The Securities Act addresses resales of
securities primarily as a means to prohibit the distribution of
securities of issuers for which there is inadequate information
available to the public,-[54]- and to protect the integrity
of the transactional registration process. This concern is
particularly important when the issuer is not yet a public
company and private sales and redistributions could serve as a
means of developing a trading market in the security without the
issuer being subjected to the registration process. It has long
been recognized that this concern is of less importance where the
---------FOOTNOTES----------
-[54]- See Preliminary note to Rule 144 [17 C.F.R.
230.144].
==========================================START OF PAGE 50======
issuer already is a reporting company and is currently subject to
ongoing disclosure requirements.-[55]-
1. Sales of Restricted Securities
A company registration system would further alleviate these
concerns by eliminating the notion of exempt private placements
and restricted securities altogether. Under full company
registration, regardless of the nature of the transaction in
which securities were initially sold by the issuer or its
affiliates, there would be no need to impose resale restrictions
on outstanding securities. All sales by registered companies and
their affiliates made under Form C-1 would have the same legal
status and carry the same or higher liability and investor
protections as registered offerings do today. For that reason,
the provisions of Rule 144 governing resales of restricted
securities would not be necessary since all shares would be
registered if issued by a registered company. A purchaser in the
secondary market would be better protected under the company
registration scheme, especially given the more current and
reliable information being provided by the issuer pursuant to the
various disclosure enhancements.
Because all issuer and affiliate sales would be deemed to be
made under the
---------FOOTNOTES----------
-[55]- See Cohen, supra n.2, at 1395.
==========================================START OF PAGE 51======
Form C-1 (where a company has opted into full company
registration-[56]-), an issuer cannot use indirect sales
through a conduit as a means to distribute securities without
registration and disclosure, nor as a means to escape liability.
All securities issued under the company registration system would
be subject to Section 11 liability for any misleading statements
or information in the issuers' public reports that are
incorporated by reference into the registration statement at the
time of original issuance by the issuer. This liability would
run to any purchaser that can trace the security back to the
misleading registration statement. Indeed, in the case where it
can be demonstrated that the seller was a mere "strawman" for the
issuer and was selling on its behalf, the resale itself will be
considered an issuer transaction made pursuant to the
registration statement.
Since all securities would be deemed registered upon
issuance under company registration, the Committee has determined
that a safe harbor from the broad definition of "underwriter" in
Section 2(11) of the Securities Act should be adopted for
purposes of resales of securities issued by a registered company.
The safe harbor would limit the application of the underwriter
---------FOOTNOTES----------
-[56]- As noted (supra p. 5-6), a registered company
opting for full participation in the system would
have the choice whether to sell non-convertible
debt securities within the system. However, no
such choice would be available for equity
securities and securities convertible to equity --
all such securities issued by the fully
participating company must be sold pursuant to the
company registration system.
==========================================START OF PAGE 52======
concept to persons engaged in the business of a broker-dealer,
whether or not registered as such (including banks not required
to register as a broker-dealer), who participate in the
distribution of securities by an issuer or an
affiliate.-[57]- The Commission may wish to consider
whether it would be helpful to specify a time after which a
broker-dealer would no longer be deemed a participant in the
distribution (e.g., after it has sold out its allotment or the
expiration of six months, whichever is earlier), especially if
the Commission otherwise shortens the period in which a
distribution will be deemed to occur. The purpose of this
provision would be to ensure that only the underwriting firms
participating in the offering incur responsibility under Section
11 liability and due diligence provisions, while providing more
certainty as to when resales may freely take place.
---------FOOTNOTES----------
-[57]- The use of a narrower definition of underwriter
for the purpose of resales of securities sold
under the company registration system is
appropriate, since it would only apply in the
context of registered offerings. Except in the
case of broker-dealer firms in the business of
underwriting securities, in the absence of
arrangements with, or compensation for selling on
behalf of, the issuer, and if certain other
conditions are satisfied, nonaffiliated purchasers
in a registered offering have not been considered
to be underwriters under current interpretations
of that definition, even when they purchase a
substantial portion of the registered offering or
immediately resell the securities following the
offering. See American Council of Life Insurance,
SEC No-Action Letter, [1983 Transfer Binder] Fed.
Sec. L. Rep. (CCH) 77,526 (May 10, 1983).
==========================================START OF PAGE 53======
A final benefit of this more narrow definition of
underwriter would apply in the context of acquisitions. Current
law deems affiliates of acquired companies to be underwriters
when they resell the registered company's securities received in
the acquisition.-[58]- Registered companies participating
fully in the system, and thus entitled to take advantage of this
narrower definition of underwriter, could make acquisitions
without issuing restricted stock to the acquired company's
insiders.
---------FOOTNOTES----------
-[58]- See Securities Act Rule 145(c) [17 C.F.R.
230.145(c)].
==========================================START OF PAGE 54======
2. Sales by Affiliates
Under the current system, substantial affiliate resales
(those exceeding the limits set by Rule 144) have been subjected
to registration requirements, even with respect to nonrestricted
securities purchased by the affiliate in registered transactions
or in the open market. Again, the primary purpose of this
provision was to ensure that companies do not create a public
market for their shares indirectly through sales by their
controlling or controlled persons when adequate information is
not available concerning the issuer.
As in the case of restricted securities, the need to
preserve existing constraints on affiliate resales largely
disappears under a company registration scheme. Since registered
companies would be subject to continuous reporting obligations,
and the issuer would be exposed to statutory liability for any
sales made by the issuer to an affiliate, or any subsequent
purchaser from the affiliate who can trace the securities back to
the company registration statement, there is little concern that
an affiliate may be acting as a conduit to facilitate the
distribution of unregistered securities without the protections
of the registration process.
Similarly, resales by affiliates should not require
prospectus disclosure since the sale would not affect the
financial condition of the issuer. The antifraud, beneficial
ownership, and Section 16 "insider" reporting and short-swing
profit rules, all promulgated under the Exchange Act, apply to
==========================================START OF PAGE 55======
ensure adequate disclosure of these transactions, to the extent a
sale by an affiliate impacts on the control of the issuer or the
available supply of its securities in the public markets, or is
indicative of possible insider trading.-[59]-
The Committee proposes, therefore, that the class of
persons subject to the registration requirements and resale
limitations be significantly narrowed. In the case of registered
companies taking full advantage of the company registration
system, those persons subject to resale restrictions would
include only holders of 20 percent of the voting power, or
holders of 10 percent of the voting power with at least one
director on the board, persons who can be presumed to be in a
position to exercise control.-[60]- That presumption of a
control relationship would be rebuttable.-[61]- Also
---------FOOTNOTES----------
-[59]- Milton Cohen expressed the view that delivery of a
prospectus for affiliate sales was unnecessary in
most instances. Cohen, supra n.2, at 1395. This
concern could be further addressed under full
company registration system by requiring
affiliates to make prior disclosure of plans to
make sales, similar to the notice provided on Form
144 today. A similar notice provision for 15%
holders was proposed by the ALI Code. See Federal
Securities Code 510 (Am. Law. Inst.) (Proposed
Official Draft 1978).
-[60]- A shareholder would not be deemed to hold a board
seat merely as a result of its voting power
derived pro rata as a holder of a class of
securities. Rather, the right to appoint a member
of the board must be derived by independent
agreement or arrangement with the issuer,
management or other shareholders.
-[61]- While a finding of "control" will always depend
upon an examination of all the facts and
(continued...)
==========================================START OF PAGE 56======
included would be the CEO and inside directors, as well as the
director representatives of the controlling shareholders.
This class of persons subject to resale limitations is
significantly narrower than that prescribed by current law, which
under certain circumstances could encompass all executive
officers or directors, as well as significant
shareholders.-[62]- The narrower class is justified in
light of the diminished concern with affiliates acting as
conduits for the distribution of issuer securities.-[63]-
This proposal affects solely the registration and resale
requirements, not any other provisions under the federal
securities laws, such as the "controlling person" liability
---------FOOTNOTES----------
-[61]-(...continued)
circumstances, one significant factor in
determining who controls the issuer for Securities
Act registration purposes has been the ability to
obtain the signatures necessary to complete the
registration process. See III L. Loss & J.
Seligman, Securities Regulation 1111 (3d ed.
1989); Cohen, supra n.2, at 1393.
-[62]- See generally A.A. Sommer, Jr., Who's "In Control"
-- the SEC, 21 Bus. Law. 559, 567-83 (1966).
-[63]- The Committee recognized that contractual and
other relationships also can give rise to a
control relationship. However, the Committee
believes that, given the inability to use conduits
to avoid registration or liability under the
company registration system, the narrower
application of the resale restrictions is
appropriate.
==========================================START OF PAGE 57======
provision under the Securities Act or the Exchange
Act.-[64]-
The Committee considered requiring all sales by those
affiliates subject to resale restrictions under full company
registration, no matter how de minimis, to be registered under
the C-1 registration statement, thereby eliminating the need to
apply Rule 144 to these affiliate resales as well. However, in
the Committee's view, that approach would be unnecessarily broad
and restrictive, since affiliates are currently permitted to sell
without registration if they comply with Rule 144. Accordingly,
affiliate sales meeting the applicable Rule 144 conditions need
not be made under the company registration statement.
The current flexibility of Rule 144 should provide those
affiliates still subject to resale limitations under company
registration with ample opportunity to sell securities without
the necessity of obtaining the issuer's assistance in completing
the registration process, as well as the payment of a fee, at the
time of the resale. Issuers certainly can oversee resales by
their CEO and inside directors to ensure compliance with these
requirements, and avoid sales at a time when the issuer has not
disclosed material developments to the market. The same is true
in the case of significant shareholders who purchased from, or at
---------FOOTNOTES----------
-[64]- Section 15 of the Securities Act [15 U.S.C. 77o];
Section 20(a) of the Exchange Act [15 U.S.C.
78t(a)].
==========================================START OF PAGE 58======
the invitation of, the issuer.-[65]- In those instances,
an issuer can protect itself by obtaining a contractual agreement
from the affiliate not to resell without the issuer's permission.
In those cases where the affiliate's investment in the
company was uninvited, the Committee considered whether special
provision should be made to allow the affiliate to sell under the
company registration system without the cooperation of the
issuer. Unlike the case with current law, during the pilot, the
affiliate of a company participating fully -- with no private
placement exemption -- in the system cannot simply sell a large
block of the company's securities in one or more exempt private
placements, since that sale would be deemed registered for
purposes of the Securities Act.-[66]- That registered sale
would require an updating of the issuer's disclosure at the time
of sale in order to comply with the Securities Act. The
Committee did not want an issuer to be subjected to Securities
Act liability for a resale transaction that it could not control.
The Committee believed that it would be extremely rare that an
---------FOOTNOTES----------
-[65]- The issuer's cooperation often is required for an
investor to obtain affiliate status through
significant purchases of outstanding securities as
a result of state takeover statutes and "poison
pill" rights plans.
-[66]- As discussed below, under an option to elect a
modified version of the company registration
system, the issuer could preserve the option to
conduct exempt private placements for itself and
all affiliates. See infra p. 42-45.
==========================================START OF PAGE 59======
issuer would object to an uninvited affiliate reselling into the
market in a broad-based distribution. Consequently, the
potential for a significant shareholder of a registered company
to be locked into its investment by an uncooperative issuer seems
more theoretical than real. In any event, a substantial
shareholder that could not secure the assistance of the issuer in
its resales may be able to demonstrate that it does not have the
requisite control over the issuer, and thus rebut the presumption
of control in the definition of affiliate. Absent affiliate
status, the shareholder is free to resell without the
registration process and the corresponding Securities Act
liabilities.
B. Exclusions
As noted, initial public offerings would continue to be
subject to a transactional registration-type regulatory process,
since only companies that have conducted a registered public
offering would be eligible to use the company registration
system. In addition, securities not valued on the basis of the
issuing company's business and financial information, such as
asset-backed or special purpose issues, would not be eligible for
the system. Securities that are valued in part on the basis of
the issuer's performance, such as structured securities or
tracking securities (e.g., GM Series H), could be made eligible
subject to special disclosure requirements. Further, issuers
could opt in without subjecting issuances of the types of
securities currently exempt from the registration requirements of
==========================================START OF PAGE 60======
the Securities Act to the company registration system. Thus,
commercial paper, tax-exempt private activity bonds and bank-
guaranteed debt would remain exempt from the system.
Even in the case of a company taking full advantage of the
system, the Committee concluded that, during the pilot stage,
placements of straight (i.e., non-convertible) debt could be
excluded from the company registration system at the issuer's
election; debt securities, of course, also could be included at
the issuer's option. The Committee believed that straight debt
placements, either on an agency basis or into the Rule 144A
market, are efficient, involve mostly institutions, and therefore
may not necessitate the protections provided by the registration
scheme. Moreover, unlike the case with equity securities, the
integration and restricted securities concepts do not appear to
have created significant problems in the debt markets due to the
lack of fungibility among various debt issuances.
C. Offshore Offerings
Under full company registration, purchasers of securities of
registered companies in the U.S. trading markets would have the
same disclosure and liability protections regardless of whether
the securities initially were sold overseas or in this country.
Offshore sales to non-U.S. persons would not have to be covered
by the company registration statement. The adoption of a company
registration system is not intended to result in an indirect
assertion of U.S. registration jurisdiction over an issuer's
offshore financing transactions. However, under full company
==========================================START OF PAGE 61======
registration, in light of the concerns regarding flowback of
equity securities initially sold offshore, a participating issuer
would be required to include equity securities on its company
registration statement on the Form C-1 for purposes of their
reentry into the United States in flowback transactions. The
amount to be registered for this purpose would be based on the
issuer's reasonable estimate of the likely flowback into the
United States. Thus, U.S. purchasers of equity securities
initially offered overseas would benefit from whatever statutory
protections are afforded to secondary market purchasers by
Section 11 of the Securities Act for the period of the applicable
statute of limitations, running from the time of the initial sale
by the issuer. As a result, the concerns that have arisen with
respect to Regulation S offerings of equity securities with an
established trading market in this country-[67]- would
evaporate as a practical matter in the context of sales by
registered companies, because U.S. purchasers would be protected
to the same extent as if the securities initially had been issued
in the United States.
D. Preservation of Transactional Exemptions
The Committee engaged in considerable discussion on whether
companies participating in the company registration system should
be able to rely on exemptions for private placements and other
---------FOOTNOTES----------
-[67]- Problematic Practices Under Regulation S,
Securities Act Rel. 7190 (June 27, 1995) [60 FR
35663 (July 10, 1995)].
==========================================START OF PAGE 62======
transactions that are available today from the registration and
liability provisions of the Securities Act. On the one hand, the
inclusive nature of company registration ensures that issuers
could not use conduits to avoid liability that results from the
registration of securities. Treating all sales as registered
generally eliminates the need for such concepts as restricted
securities, integration, general solicitation and flowback of
unregistered securities issued abroad, with respect to securities
issued by companies opting into the system. To the extent
company-registered issuers or affiliates are permitted to engage
in unregistered private placements, the need for resale
restrictions and other concepts that burden the current scheme
would remain, thereby costing the new system some of its expected
benefits. On the other hand, the loss of the private placement
option, and thus the potential for increased liability and
possible disclosure concerns arising from the need to update the
company's public disclosures and file the transactional
information, as well the need to pay a registration fee, when
making a company-registered offering could be a deterrent to the
use of the company registration system.-[68]-
---------FOOTNOTES----------
-[68]- Transcript of May 8, 1995 Advisory Committee
Meeting at 177 (statements of Professor Coffee).
The same concern may arise with respect to the
ability to conduct an offshore offering under
Regulation S without having to register the
securities offered for flowback purposes or
otherwise. If the issuer is contemplating an
acquisition, Regulation S offers a means for the
issuer to avoid delaying the offer until the full
acquisition disclosure is available. The
(continued...)
==========================================START OF PAGE 63======
Therefore, to permit a fair test of the company registration
concepts during the pilot stage, the Committee believed that
issuers should be afforded the option of continuing to conduct
private placements, while still taking advantage of most of the
benefits of the system. Companies could choose either to waive
transactional exemptions, such as those for small issuances
(3(b) and Regulation A), private offerings (4(2)) and
Regulation D (Rules 504, 505 and 506)), intrastate offerings
(3(a)(11) and Rule 147), issuer exchange offers (3(a)(9)), and
transactions pursuant to fairness hearings (3(a)(10)), as well
as the jurisdictional safe harbor of Regulation S, or determine
to preserve the option to exclude those transactions from the
company registration system under a modified or less
comprehensive version of this system.
In the case of participation in full company registration,
other than the limited exclusions for exempt securities discussed
above (commercial paper, bank debt, etc.), all issuer and
affiliate sales (outside Rule 144) would be deemed "registered"
for Securities Act purposes. Thus, regardless of the nature of
---------FOOTNOTES----------
-[68]-(...continued)
Commission has proposed to address that concern by
conforming the acquisition disclosure and
accounting requirements under the Securities Act
to the same standard as under the Exchange Act.
See Streamlining Disclosure Requirements Relating
to Significant Business Acquisitions and Requiring
Quarterly Reporting of Unregistered Equity Sales,
Securities Act Rel. 7189 (June 27, 1995) [60 FR
35656 (July 10, 1995)] (the "Streamlining Business
Acquisitions Release").
==========================================START OF PAGE 64======
the transaction in which the securities were originally issued,
the securities would be freely tradeable. Purchasers of those
securities from the issuer or an affiliate (outside Rule 144)
would enjoy the same remedies and disclosure protections as would
be the case if they purchased securities issued today in a
registered public offering.
Companies participating in the modified version of the
system still would benefit from the "file and go" registration
process, so long as they agree to the disclosure enhancements.
Securities issued in excluded transactions, however, would be
restricted securities subject to current holding periods and
resale limitations to the same extent they are today.-[69]-
The new, more limited, applicability of resale limitations to
affiliates and definitions of underwriter would not apply with
respect to those issuers and transactions.-[70]- These
---------FOOTNOTES----------
-[69]- Although certain of the forms of exempt
transactions do not result in the issuance of
restricted securities under current law, they are
subject to limitations and restrictions that
condition the exemption, as well as potential
integration, that would not apply if conducted on
a registered basis.
-[70]- The company registration model envisioned by the
ALI Code also provided for exempt limited
offerings. Those offerings were defined as sales
up to 35 buyers as well as an unlimited number of
institutional investors. See Federal Securities
Code Section 242(b) (Proposed Official Draft 1978)
(Am. Law Inst.). While strict resale limitations
were not imposed, securities issued in those
transactions could not be held by more than 35
noninstitutional investors for one year after the
issuance in the case of seasoned issuers. Id.
==========================================START OF PAGE 65======
exempt offerings, however, would not be subject to integration
with registered offerings conducted on the Form C-1. This dual
approach, while adding complexity to the company registration
system during the pilot stage, would permit issuers and their
purchasers to weigh the costs and benefits of full registration
of all transactions versus private placements.
In the Committee's view, even during the pilot stage, the
benefits resulting from registration, including the issuance of
freely tradeable securities in what otherwise would have been a
private transaction resulting in restricted securities, should
outweigh any additional costs imposed by registering the
securities under the system. In addition, given the extensive
representations and warranties that normally are provided to
purchasers in a private placement, the fact that company-
registered transactions would be subject to Securities Act
statutory liability should not be a significant deterrent.
Similarly, the discount that normally adheres to private
placements (as high as 20 percent for equity securities) should
far outweigh the registration fee paid in registered offerings
(.034 percent).
E. Limited Placements
An issuer participating in the full company registration
system may be concerned that it will not be able to raise capital
at a time when it is not in a position to disclose information
currently required in a registered offering. This situation may
arise due to a material business development that must remain
==========================================START OF PAGE 66======
nonpublic for legitimate business reasons, the need to update
financial statements that have "gone stale," its offering
documentation (for example, the Form 8-K filing) not being
completed in time to take advantage of a market opportunity, or a
company's auditor not consenting to the use of its report in
connection with a registered offering. All of these reasons may
induce a company to continue to conduct private placements. In
these cases, an issuer could conduct a limited placement of
securities to one or more accredited investors, so long as those
securities (and any price-related securities) are not traded by
the purchaser until full disclosure is provided to the public
through a Form 8-K or other public filing of such information and
its inclusion in the Form C-1. Of course, the issuer still would
have to make full disclosure to the purchaser at the time of the
sale (which could be done in writing as well as orally), subject
to whatever confidentiality agreements with the purchaser that
the issuer deems necessary. In this manner, once the disclosure
is made to the public, the purchaser would have freely tradeable
securities. The duration of any restriction on resale would be
determined by the parties, not a fixed holding period set by
Commission rule. In addition, unlike an exempt offering, the
liability provisions of the Securities Act would attach to the
securities originally issued in these limited offerings.
==========================================START OF PAGE 67======
IV. Disclosure Enhancements Under the Recommended Company
Registration Model
Adoption of a company registration system creates the
opportunity for raising the quality and integrity of
disclosure provided routinely to the markets through
the company's Exchange Act reports in a variety of
ways: (a) by requiring a heightened focus on the part
of senior managers and directors on their existing
financial reporting responsibilities; (b) by increasing
the scope and currency of disclosure to the markets of
specified material developments; and (c) by increasing
the opportunity for outside gatekeepers or monitors to
participate. Because company registration relies on
the integrity of publicly available information and an
efficient market for an issuer's securities, adherence
to the recommended enhancements would be a condition to
continued participation in the company registration
system. As a result, investors in the secondary
trading markets, as well as those participating in
primary offerings, would benefit from more
comprehensive, current and reliable information.
As envisioned by the Committee, company registration relies
heavily on the public availability of accurate and complete
information relating to a registered company's business and
financial condition. Viewed in this light, the Committee's model
of company registration represents a logical extension of the
Commission's integrated disclosure scheme. Despite integration
and a gradual shift in emphasis of Commission staff review over
the past decade away from Securities Act transactional documents
and toward Exchange Act periodic reports, there remain
substantial differences in the quality of the disclosures
provided under each statute.-[71]- The expense of
---------FOOTNOTES----------
-[71]- As such, not much has changed since Milton Cohen
observed in 1985:
(continued...)
==========================================START OF PAGE 68======
continuous due diligence of the caliber expected in a primary
distribution, coupled with issuers' legitimate need to control
the timing of public disclosure of material developments, make it
difficult for Exchange Act documents always to achieve true
parity in terms of reliability and currency with documents filed
in connection with registered offerings.-[72]- However,
---------FOOTNOTES----------
-[71]-(...continued)
Disclosure for [Exchange] Act purposes still tend to be
taken far less seriously, and to be of lower quality,
than those historically provided, and still aspired to,
under the [Securities] Act.
. . .
Because of this disparity, and the disparity
in liability provisions that it reflects, the
SEC has considered it necessary for a
registrant, on the occasion of a public
offering, not merely to supplement its latest
[Exchange] Act disclosures but to bring them
within the coverage of section 11 by, at
least, incorporating them by reference into a
[Securities] Act registration statement.
Cohen, Unfinished Business, supra n.37, at 992. See 1977
Advisory Committee Report, supra n.4, at 425-26.
-[72]- Traditionally, there have been "[t]wo principal
qualitative reasons for placing particular stress"
on Securities Act filings by comparison with
Exchange Act filings, as suggested by the Wheat
Report in 1968:
First, the buyer of securities in an initial
distribution is in a somewhat different position from
the buyer in the trading markets. Not only the
[Securities] Act but much of the legislation previously
passed by the states in the securities field rests on
this premise. The compensation that dealers and
salesmen receive when they participate in a
[Securities] Act offering is almost always appreciably
more generous than that customarily received in
exchange or over-the-counter trading. New securities
have to be distributed in short order. Special efforts
(continued...)
==========================================START OF PAGE 69======
the Committee believes that additional improvements in Exchange
Act disclosures -- especially with respect to the attention paid
by senior management, outside directors and other gatekeepers or
monitors -- would achieve more fully the intent of the Commission
when it integrated the disclosure requirements of the two
statutes in 1982.
Accordingly, the Committee recommends that the Commission
implement a series of mandatory disclosure enhancements
applicable to registered companies. Voluntary, but encouraged,
measures such as SAS No. 71 reviews and appointment of a
disclosure committee, should operate in tandem with the mandated
---------FOOTNOTES----------
-[72]-(...continued)
are necessary if disclosure is to serve as a useful
shield against the dangers inherent in such a
situation.
Second, new public offerings, especially those for the
accounts of issuers, have a special economic
significance. The transaction in which one investor
purchases from another a security originally issued
many years ago has less impact on the economy than one
in which the investor's dollars go directly into the
treasury of a corporation in order to help it to
develop a mine, construct a new plant, or exploit a new
technological development. A special disclosure effort
may well be justified when allocation of capital in a
free society is affected. . . .
. . .
For these reasons, among others, quantitative
differences between the new issue and trading markets
must be regarded with caution. Nevertheless, in the
Study's judgment, the statistics demonstrate the need
to achieve a better balance in disclosure policy, with
greater emphasis on continuing disclosures for the
trading markets.
Wheat Report, supra n.3, at 60-61.
==========================================START OF PAGE 70======
enhancements to facilitate greater outside director, auditor, and
underwriter attention to existing Securities Act due diligence
responsibilities. Both the mandatory and voluntary measures
recommended by the Committee, therefore, should improve the
quality and integrity of corporate disclosure in connection with
not only primary distributions, but also the Exchange Act reports
upon which the trading markets depend.
A. Mandatory Disclosure Enhancements
Committee member Robert Elliott has urged the Committee to
expand its primary focus on the reliability of the corporate
reporting process to address perceived problems in the content of
the resultant disclosures. Mr. Elliott raised the concern,
echoed in the Jenkins Committee Report,-[73]- that much
SEC-prescribed financial reporting may have become obsolete,
redundant of generally accepted accounting principles ("GAAP") or
otherwise of marginal utility to the investing
public.-[74]- These financial reporting issues are
---------FOOTNOTES----------
-[73]- See supra n.39. Mr. Elliott was a member of the
Jenkins Committee.
-[74]- In a letter dated November 10, 1995 from Mr.
Elliott to Committee Chairman Wallman, Mr. Elliott
suggested that the Commission conduct research
into investor informational demands that focuses
on "[t]he trade-off between relevance and
reliability," noting that Jenkins Committee data
show that investors "would prefer more relevance,
even at the cost of reliability." See Documents
for Advisory Committee Meeting, November 21, 1995,
Tab E (Letter dated November 10, 1995 from Robert
Elliott to Commissioner Wallman at 2). As Mr.
Elliott points out:
(continued...)
==========================================START OF PAGE 71======
relevant to the Commission's administration of its disclosure
program regardless of whether the Commission determines to move
to a company registration system. In addition, the
recommendations of the Jenkins Committee already were being
considered by representatives of the affected constituencies
prior to the establishment of the Advisory Committee.-[75]-
For these reasons, the Committee determined to defer to these
other ongoing evaluations of the need to reform financial
---------FOOTNOTES----------
-[74]-(...continued)
If registrants are willing to pay some measure of cost
to become C-1 companies, they should be just as willing
to devote that measure to the incremental relevance it
would purchase as to the incremental reliability it
would purchase. This is a policy choice that the SEC
can and should make for the sake of its investor-
protection mission.
. . .
Companies often misperceive costs because they fail to
count the capital-cost reduction benefit from clear,
honest, complete disclosure policies. The SEC should
undertake to study these benefits through independent
economic analysis and make the case to registrants that
disclosures helpful to investors' decision making
provide capital-cost reductions (as long as they don't
reveal matters to competitors that (a) are economically
deleterious and (b) the competitors didn't already
know).
Id. at 2-3.
-[75]- The Committee was advised by the analyst community
that it would be premature to take up the Jenkins
Committee Report recommendations before they are
thoroughly examined by the accounting, corporate
and end-user communities, as well as the FASB.
See Documents for Advisory Committee Meeting,
September 29, 1995, Tab E (Letter dated September
27, 1995 from the AIMR to Commissioner Wallman, at
6).
==========================================START OF PAGE 72======
reporting and confine its recommendations in this area to the
substantial enhancement of reporting procedures and the
reliability of reported information. The Committee did make
substantive reporting proposals, however, such as the proposed
changes to the existing Forms 10-K and 8-K disclosures, where it
believed they were necessary.-[76]-
1. Enhanced Involvement by Senior Management
When the Commission mandated in 1980 that senior managers
and at least a majority of the board of directors sign a
registrant's annual report on Form 10-K,-[77]- the
Commission expected management and the board to focus their
attention on the disclosures in the annual report. In practice,
---------FOOTNOTES----------
-[76]- The Committee also considered, but rejected as
unnecessarily burdensome when balanced against
likely investor benefits, a requirement that
registered companies report in a timely manner all
material developments similar to the obligation
issuers now incur as a condition to listing on the
New York Stock Exchange. See NYSE Listed Company
Manual 202.05 (listed companies expected to
"release quickly to the public any news or
information which might reasonably be expected to
materially affect the market for its securities");
see also American Stock Exchange Company Guide
1102, and National Association of Securities
Dealers By-laws, Schedule D. For substantially
the same reason, the Committee did not require
registered companies to procure auditor
attestation of their management discussion and
analysis, or obtain an opinion of counsel on
periodic reports.
-[77]- See General Instruction D to Form 10-K, adopted in
Amendments to Annual Report Form, Related Forms,
Rules, Regulations,and Guides: Integration of
Securities Acts Disclosure Systems, Securities Act
Rel. 6231 (Sept. 2, 1980) [45 FR 63630 (September
25, 1980)] (the "Annual Report Release").
==========================================START OF PAGE 73======
however, some of these corporate officials still devote far less
attention and care to the preparation and review of the Form 10-K
and other periodic and current Exchange Act reports than are
generally seen in the Securities Act context. When presenting
and discussing this issue, both the Committee and its staff
repeatedly were advised that a routine practice among some
reporting companies is merely to have senior management (and
directors for the Form 10-K) execute the signature pages of a
required Exchange Act report without receiving, and hence
reviewing, the remainder of the document.-[78]-
Whatever the causes of the disparities between the level of
attention given to the preparation of Securities Act and Exchange
Act disclosure documents, the result is clear -- the senior
management of many registrants could do far more than they are
doing today to assure the quality and reliability of information
disseminated to the nation's public trading markets. Two
measures recommended by the Committee are intended to heighten
top managers' compliance with present reporting responsibilities:
(i) the certification by top management to the Commission that
specified Exchange Act disclosure documents have been reviewed by
them and do not, to the reviewing manager's knowledge, contain
any materially false or misleading information, and (ii) a senior
management report addressed and submitted to the audit committee
of the board of directors (or its equivalent) describing
---------FOOTNOTES----------
-[78]- See pp. 46 and 51 of Appendix A to the Report.
==========================================START OF PAGE 74======
procedures adopted both to ensure the integrity and accuracy of
such disclosure documents, and to prevent insider trading.
a. Top Management Certifications
In requiring certification by responsible senior managers
that each Exchange Act report has been read, and that the
particular manager is not aware of any material misstatement or
omission in that report, the Committee hopes that the
Commission's longstanding objective of encouraging management (as
well as directors, accountants and attorneys) to refocus its
attention on the sufficiency of Exchange Act filings in order to
instill "a sufficient degree of discipline ... in the [integrated
disclosure] system to make it work" might be
fulfilled.-[79]- Rather than create additional
---------FOOTNOTES----------
-[79]- Annual Report Release, supra n.77 (discussing
reasons for imposing obligation to sign the Form
10-K upon the issuer's principal executive
officer, certain additional officers, and a
majority of the board of directors). Compare 1977
Advisory Committee Report, supra n.4, at 426-27
(rejecting a suggested requirement that a majority
of the issuer's board of directors sign each
Exchange Act report that would be incorporated by
reference into a short-form registration
statement, based on commenters' concerns that the
increased liability the director signatories thus
might incur would deter use of the short form;
however, the Committee "encourage[d] the
Commission to consider this concept as a possible
means of upgrading the quality of reporting by
improved attention by directors and top officers
to their filings and the consequent enhanced
possibility of liability"). Without addressing
directly the 1977 Advisory Committee's conclusion,
the Commission in expanding the Form 10-K
signature requirement to require a majority of the
board to execute this document regardless of its
potential incorporation by reference into a
(continued...)
==========================================START OF PAGE 75======
managerial duties or liabilities, the new certification
requirement is intended to prompt the dissemination of more
reliable and informative disclosures to the markets for
registered companies' securities. An affirmative attestation
obligation may well succeed in accomplishing what signature
requirements alone apparently have not -- underscoring top
management's duty to monitor the accuracy and integrity of all
information contained in its corporate reports. The Committee
recommends that a minimum of two of four designated senior
executive officers (or their functional equivalents) in a
position to influence the content and quality of a registered
company's disclosures -- the Chief Executive Officer, the Chief
Operating Officer, Chief Financial Officer, or Chief Accounting
Officer -- provide this attestation to the Commission in
connection with the filing of each Form 10-K, Form 10-Q, and
mandatory Form 8-K.-[80]- In the Committee's view, these
---------FOOTNOTES----------
-[79]-(...continued)
Securities Act form, reasoned that "this added
measure of discipline is vital to the disclosure
objectives of the federal securities laws, and
outweighs the potential impact, if any, of the
signature on legal liability." Annual Report
Release, supra n.77 [45 FR at 63630].
-[80]- A Form 8-K must be filed in connection with any
one of the following per se material events: (a)
change in control of the registrant (Item 1); (b)
acquisition or disposition of a significant amount
of assets outside the ordinary course of business
(Item 2); (c) bankruptcy or receivership (Item 3);
(d) changes in registrant's certifying accountants
(Item 4); and (e) resignations of directors (Item
6). The five additional mandatory 8-K line items
that the Committee recommends the Commission
(continued...)
==========================================START OF PAGE 76======
four senior officials (or their functional equivalents) are in
the best position to ensure that the company's disclosures fully
and fairly describe the company's financial condition, results of
operations and prospects.
b. Management Report to the Audit Committee
Complementing the requirement of senior management
attestation, the Committee also recommends the adoption of a
management report addressed to the audit committee of the board
of directors on mechanisms established to assure accurate and
complete Exchange Act reporting. Specifically, the management of
registered companies should be required to prepare and submit to
the board's audit committee (or a functionally equivalent
committee, including the disclosure committee if appointed and
different from the audit committee, or in the absence of either,
the entire board) a report describing the company's practices and
procedures, if any, to assure the integrity of all periodic and
current reports filed under the Exchange Act. This report should
also contain a description of any procedures adopted by the
company to deter and/or detect insider trading abuse.-[81]-
---------FOOTNOTES----------
-[80]-(...continued)
adopt, discussed infra at p. 55-56, also would
trigger the proposed attestation obligation.
However, no such obligation would result from the
voluntary filing of a Form 8-K pursuant to Item 5
thereof.
-[81]- For example, many public companies require all
executive officers to obtain prior approval of any
purchase or sale of company securities. The
Committee included this provision because of the
belief that appropriate mechanisms to deter
(continued...)
==========================================START OF PAGE 77======
The Committee suggests that the Commission require the new report
to be filed as an exhibit to the registered company's Form 10-K.
Absent a material change in its content, the report would not
need to be refiled on an annual basis.
While the Committee is not recommending that the Commission
compel the adoption of any specific set of procedures, public
disclosure of actual procedures used by registered companies to
ensure the integrity and quality of their Exchange Act filings
should lead to the development of a private sector set of "best
disclosure practices." Members of the board, investors and
management of registered companies likely will explore whether
procedures followed by competitors and comparable issuers might
function to improve the quality of their own reports. The scope
of the required "procedures" disclosure should include a detailed
description of the steps currently taken by the company to
prepare its required reports so that investors and others can
gauge the quality of the preparation procedures.
This report would not require an assessment of the overall
adequacy of a registered company's broader system of internal
controls designed to protect and preserve the integrity of
---------FOOTNOTES----------
-[81]-(...continued)
insider trading will increase the expected level
of integrity of the company's public reports, and
because the reduction in resale limitations on
some insiders could warrant better controls and
monitoring within a company on insider
transactions.
==========================================START OF PAGE 78======
financial reporting, compliance with GAAP, and
operations.-[82]- Thus, the recommendation is far narrower
than prior Commission rulemaking proposals calling for management
reports on internal controls.-[83]- The Committee does not
---------FOOTNOTES----------
-[82]- See ABA Committee on Law and Accounting,
"Management" Reports on Internal Control: A Legal
Perspective, 49 Bus. Law. 889, 920 (1994) (the
"ABA Report") (observing that "it appears that the
SEC and the COSO [Committee of the Sponsoring
Organizations of the Treadway Commission, a
private-sector group of accounting experts formed
in 1985 to study the U.S. financial reporting
system] believe that controls cannot be immutably
characterized as exclusively related to just one
category of objectives -- of operations, or
financial reporting, or compliance -- and for this
reason, they no longer will use the term internal
accounting control").
-[83]- See Report of Management's Responsibilities,
Securities Act Rel. 6789 (July 19, 1988) [53 FR
28009 (July 26,1988)] (proposing a management
report to the board of directors or its audit
committee -- to be published in the company's Form
10-K and annual report to shareholders -- to
describe management's responsibilities for the
preparation of the company's financial statements
and other related information and for establishing
and maintaining a system of internal controls for
financial reporting.) Almost a decade earlier,
the Commission had proposed to require inclusion
in each Form 10-K and annual report to
securityholders (filed under the proxy/information
statement rules) of a statement of management's
opinion as to whether the registrant's system of
internal accounting controls offered reasonable
assurance that only appropriately authorized
transactions were executed consistent with the
books and records provisions of the Foreign
Corrupt Practices Act of 1977 (now codified in
Section 13(b)(2) of the Exchange Act [15 U.S.C.
78(m)(b)(2)]), and that transactions were
recorded as necessary to permit preparation of
financial statements in accordance with GAAP and
to maintain accountability for assets. See
Statement of Management on Internal Accounting
(continued...)
==========================================START OF PAGE 79======
believe it is necessary, and therefore recommends that the
Commission not require, senior management of registered companies
to provide a public evaluation of internal controls. Similarly,
the Committee does not support a requirement that the report
represent that prescribed procedures were followed with respect
to the preparation of any particular filing. Indeed, an adequate
description of procedures could recognize expressly management
discretion to depart from the standards under appropriate
circumstances.-[84]-
---------FOOTNOTES----------
-[83]-(...continued)
Control, Exchange Act Rel. 15772 (April 30, 1979)
[44 FR 26702 (May 4, 1979)]. This proposal was
withdrawn one year later. Statement of Management
on Internal Accounting Control, Exchange Act Rel.
16877 (June 6, 1980) [45 FR 40134 (June 13,
1980)].
-[84]- Some have raised concerns that public disclosure
of the report would expose the certifying
officials to a greater risk of private litigation
or a Commission enforcement action. The fact that
a report detailing procedures for preparation of a
document is publicly filed would not enhance a
company's potential liability in a suit premised
upon materially false or misleading disclosures
made in Commission documents. Even if viewed as
an implicit representation to the market that the
disclosed procedures were followed, it would be
difficult for a plaintiff to argue that
noncompliance with these procedures added to the
damages suffered by investors. Any such suit
would be premised on a misrepresented material
fact or material omission regarding the issuer or
its securities, not the lack of devotion to a
particular procedure. Though potentially relevant
to whether the defendant met the requisite
standard of care or mental state, a company's
procedures and management's compliance therewith
likely would be discoverable whether or not those
procedures are contained in a filed report. The
issuer could be liable, however, in a Commission
(continued...)
==========================================START OF PAGE 80======
2. Improvements in the Content and Timeliness of 1934 Act
Reporting
The Committee also recommends that the Commission effect
certain enhancements to the content and timeliness of corporate
disclosures provided to the markets by companies participating in
the company registration system. These enhancements increase the
currency of disclosure of material developments relating to a
registered company, and add key information on investment risk to
the annual report on Form 10-K.
a. More Timely and Informative Reports on Form 8-
K
The Committee recommends that expansion of the current
Form 8-K reporting obligation to mandate or accelerate disclosure
of the following five additional material developments. Of
these, two would entail no more than earlier reporting of
information already prescribed by Form 10-Q (Nos. 1 and 3,
below). The remaining three requirements would, in many
instances, already be required to be disclosed promptly either
due to general liability concerns under antifraud
provisions-[85]- or listing requirements.-[86]-
1. Material modifications to rights of holders of
registered company securities, whether favorable or
unfavorable, now reportable only on a quarterly basis
---------FOOTNOTES----------
-[84]-(...continued)
action for a materially false or misleading filing
if the reports were, for example, fraudulent.
-[85]- See Basic Inc. v. Levinson, 485 U.S. 224 (1988).
-[86]- See, e.g., NYSE Listed Company Manual 2.
==========================================START OF PAGE 81======
in Form 10-Q.-[87]- A common criticism of
quarterly reports today is that this and other key
information is stale by the time it reaches the broader
investing public, whereas more sophisticated
institutional investors and analysts obtain timely
access to such information directly from senior
management. The Committee believes that more prompt
disclosure of important changes in securityholder
rights, such as the imposition of restrictions on (or
cessation of) dividend payments or the elimination of
preemptive rights, both of which currently need not be
reported until 45 days after the end of the quarter in
which they occur, should level any perceived
informational imbalance among investors and improve
market efficiency.
2. Resignation or removal of any of a registered company's
five most senior executive officers, currently required
in the Form 8-K exclusively for directors. Because
general principles of materiality and listing standards
in any event often result in prompt disclosure of the
termination of the CEO and other members of top
management,-[88]- the creation of a bright line
test prescribing the timing of and vehicle for such
disclosure should not impose appreciably greater
compliance burdens on registered companies when
measured against the obvious investor and market
informational benefits.
3. Specified material defaults upon senior securities,
which today must be disclosed solely in Form 10-
Q.-[89]- For the same reasons outlined above,
the Committee recommends that the Commission accelerate
disclosure of this information.
4. Sales of a significant percentage of the company's
outstanding equity, whether in the form of
common shares or convertible securities, or made on a
registered or exempt basis. In proposing to require
quarterly disclosure of unregistered equity sales
during the covered period, whether pursuant to a
---------FOOTNOTES----------
-[87]- See Item 2 of Form 10-Q.
-[88]- See NYSE Listed Company Manual 204.15 ("[p]rompt
notice is required to be given to the exchange of
any changes in directors or officers of the
company").
-[89]- See Item 3 to Form 10-Q.
==========================================START OF PAGE 82======
private placement, a Regulation S offering or
otherwise, the Commission already has recognized the
importance of this information to the
markets.-[90]- Comment was sought in the
relevant proposing release on whether this information
will be disclosed in a sufficiently timely manner if
required on Form 10-Q, or instead should be reported on
a mandatory Form 8-K or notice of sale similar to that
used for Regulation D offerings. The Committee
believes that such information is material to investors
and should be disseminated to the markets on a more
timely basis than in a quarterly report.
5. The issuer's receipt of notice from its independent
auditor that reliance on an audit report included in
previous filings is no longer permissible because of
the auditor's concerns with respect to the continuing
viability of the company as a going concern or a
variety of other matters. Also reportable would be an
issuer's effort to engage another auditor to reaudit a
period covered by a prior filed audited report, whether
due to the predecessor auditor's withdrawal of its
consent or any other reason. Timely disclosure of this
information will serve to reinforce the auditor's role
as a gatekeeper or monitor on a continuous basis, a
principal goal of company registration.
b. Form 10-K Risk Disclosure
An analysis of risks associated with investment in a
company's securities is now required in all Securities Act
filings, to the extent material.-[91]- No such requirement
currently applies in the context of Exchange Act reporting. As
a result, investors in the trading markets do not have access to
the company's own evaluation of the mix of material factors
---------FOOTNOTES----------
-[90]- See Streamlining Business Acquisitions Release,
supra n.68.
-[91]- See Regulation S-K, Item 503 [17 C.F.R. 229.503];
see also Regulation S-K, Item 506 [17 C.F.R.
229.506] (dilution of existing holders),
referenced in Forms S-1,
S-2, S-3, and S-4, among other forms.
==========================================START OF PAGE 83======
bearing on investment risk except when the company elects to
raise capital through a public offering of securities. This
information traditionally has been viewed as extremely useful for
both potential and existing investors.-[92]-
The Committee believes that participating companies,
investors, and the markets, would benefit from the inclusion of
risk disclosure requirements in the annual report on Form
10-K, for those companies that currently would be required to
provide such information in a Securities Act filing. The
Committee recognizes that for many of the companies initially
subject to the pilot, no such disclosure is currently required
and none would be required in the Exchange Act reports. However,
where a discussion of material risk factors would be required
when the company is selling its own securities, it also should be
required when investors are purchasing the securities in the
secondary trading markets. Provided that the mandatory risk
disclosures are not obscured or rendered materially false or
misleading, the company could (and, in fact, should be encouraged
to) amplify such disclosure with a discussion of the benefits of
ownership of a particular class of securities. Registered
companies would gain the advantage of being able to incorporate
the risk factor analysis by reference from the Form 10-K to
satisfy line item requirements in other documents prescribed by
---------FOOTNOTES----------
-[92]- See, e.g., Jenkins Committee Report, supra n.39,
at 29. See also 1977 Advisory Committee Report,
supra n.4, at 486-487.
==========================================START OF PAGE 84======
Commission rule under the Securities Act and the Exchange
Act.-[93]- In addition, any material change in the risk
disclosure should be provided in the next Form
10-Q.
---------FOOTNOTES----------
-[93]- Obviously, companies could not rely on general
disclosures in the Form
10-K to describe the unique risks of investing in certain
classes of complex or novel securities. Those unique risks
would have to be separately described, as today.
==========================================START OF PAGE 85======
B. Conclusion
The Committee anticipates that the mandatory disclosure
enhancements should improve the quality of information provided
by registered companies in connection not only with episodic
securities distributions, but also disclosures made on a
continuous basis through periodic and current reports filed under
the Exchange Act. Some members of the Committee have indicated
that they would not limit the recommendation to companies
participating in the company registration system since, in either
offerings under the shelf or recommended company registration
system, issuers can access the markets quickly without
intervention by the Commission staff. The current universal
shelf has raised the same concerns regarding adequate opportunity
for due diligence that also have been raised with respect to
company registration. For these reasons, some members urged that
the disclosure enhancements be made a condition to the use of the
shelf for equity offerings over a specified amount. Put simply,
the price for this speedy, unfettered access to the markets in
the case of substantial equity offerings, whether under a shelf
or the company registration system, should be the enhancements
designed to improve the level and reliability of corporate
reports and facilitate the gatekeeping function.
If required to comply with the disclosure enhancements and
investor protections (such as Form 8-K filing for non-de minimis
equity offerings) in order to conduct a shelf offering, there
would be little reason for current shelf issuers not to opt into
==========================================START OF PAGE 86======
the company registration system, at least the modified version,
in order to benefit from the added flexibility of the company
registration system. Taken together, while imposing requirements
to enhance the level of disclosure and investor protection, the
resulting system would represent a significant expansion and
liberalization of the shelf procedure.
On balance, the Committee concluded that modification of the
existing shelf registration to impose all the disclosure
enhancements is not necessary just to implement company
registration, at least on a pilot basis. At the same time, the
Committee recommends that a Form 8-K be required for non-de
minimis equity offerings conducted on the current shelf, and that
the Commission give careful consideration to whether requiring
disclosure enhancements across the board for shelf registrants as
well, could lead to measurable improvements in the current
disclosure.
V. Liability and Due Diligence Under Company Registration
Company registration will preserve the current
statutory liability provisions and, indeed, will extend
those protections to transactions that today are
conducted without registration, such as private
placements and offshore offerings. Company
registration also will promote more effective and
continuous due diligence. Directors, underwriters and
other parties with due diligence obligations will
receive more useful guidance on their ability to
consider, in meeting those obligations, the ongoing
oversight of the company's disclosures conducted by
persons who are better positioned to perform that role.
A. Liability Under Company Registration
1. Other Liability Approaches Considered
==========================================START OF PAGE 87======
The Committee considered several liability schemes that
could be applied under a company registration system with the
goal of preserving and enhancing the gatekeepers' or monitors'
existing roles in protecting investors. In recommending the
proposed company registration model and pilot project, the
Committee concluded that retention of the current liability
scheme, at least during the pilot stage, would maintain important
investor protections while achieving the objectives of company
registration, provided that additional guidance was furnished to
gatekeepers on the factors relevant to establishing a due
diligence defense under Sections 11 and 12(a)(2) of the
Securities Act.
Section 11 creates strict liability for the benefit of any
purchaser of a security sold pursuant to a materially false or
misleading registration statement on offering participants
(including the issuer, officers and directors, underwriters and
experts, such as the accountants), but provides the defendants
other than the issuer with a defense based essentially upon proof
that they engaged in a reasonable investigation and had
reasonable grounds to believe in the accuracy of the
disclosure.-[94]- Section 12(a)(2) allows purchasers to
---------FOOTNOTES----------
-[94]- Under Section 11 of the Securities Act, a lower
standard of due diligence must be met as to
"expertized" portions of the registration
statement by persons other than the certifying
expert. The defendant invoking this affirmative
defense must show that, "he had no reasonable
ground to believe and did not believe, at the time
such part of the registration statement became
(continued...)
==========================================START OF PAGE 88======
recover against their sellers (a much more narrow class than that
covered by Section 11), unless the sellers can show that they
were not negligent in failing to discover false and misleading
statements. Remedies available pursuant to Section 12(a)(1) of
the Securities Act for Section 5 violations, as well as Sections
10 and 18 of the Exchange Act, and Rule 10b-5 adopted thereunder
for fraud, also would continue to be available in the same manner
as today under the shelf registration system.
During the July 26, 1995 Advisory Committee Meeting, the
Committee analyzed, in addition to maintaining the current
liability scheme, the following alternatives:
(i) a liability structure in which issuers would incur
Section 11 liability only for IPOs and extraordinary
distributions, and Section 12(a)(2) liability for
routine transactions. Under this approach, Section
12(a)(2) would apply to all prospectus disclosure,
including information incorporated by reference;
(ii) extending Sections 11 and 12(a)(2) remedies to all
purchasers in primary offerings and in secondary market
transactions contemporaneous with the offering. The
company's total liability would have been limited to
the lesser of the dollar amount of the offering
proceeds or damages caused. Awarded damages then would
be prorated among investors in the primary and
secondary markets;
(iii) eliminating Section 11 liability and extending
Section 12(a)(2) liability to all statements by
the issuer (including those currently subject only
to Rule
---------FOOTNOTES----------
-[94]-(...continued)
effective, that the statements therein were untrue
or that there was an omission to state a material
fact required to be stated therein or necessary to
make the statements therein not misleading."
Section 11(b)(3)(C) of the Securities Act [15
U.S.C. 77k(b)(3)(C)].
==========================================START OF PAGE 89======
10b-5) regardless of whether the issuer is selling
securities or its securities are trading in the
secondary market;-[95]- and
(iv) limiting liability for a registered company's routine
financings to Rule 10b-5 liability only.-[96]-
In this regard, the Committee considered differing views on
the impact of Sections 11 and 12(a)(2). In its analysis, the
Committee found it difficult to determine the full extent of
Section 11 litigation and the effects of Section 11 liability
exposure on issuers' financing choices. According to several
commenters, there are few reported cases actually decided on
Section 11 grounds,-[97]- but in meetings with industry
representatives the Committee staff was informed that a
significant number of potential Section 11 claims are settled
without actions being instituted or without reported
decisions.-[98]-
---------FOOTNOTES----------
-[95]- For a discussion of a somewhat similar liability
scheme in which a negligence standard like Section
12(a)(2) would be extended to Exchange Act
documents, and consequently a civil remedy would
be available for purchasers of a company's
securities in the open market as well as in
capital raisings, see Margaret Bancroft,
Responding to Gustafson: Company Registration and
a New Negligence Standard, INSIGHTS, July 1995, at
14.
-[96]- See Documents for Advisory Committee Meeting, July
26, 1995, Tab C.
-[97]- Transcript of July 26, 1995 Advisory Committee
Meeting at 287 (statements of Commissioner Wallman
and Professor Coffee).
-[98]- Some have suggested, however, that Section 11(e)'s
requirement of an undertaking for the payment of
(continued...)
==========================================START OF PAGE 90======
Notwithstanding the absence of dispositive evidence of the
effect of Section 11 on disclosure practices and an issuer's
choice of whether to engage in a public or private offering, it
is the Committee's view that Section 11 liability continues to
play an integral role in compelling "truth in securities."
Congress explicitly recognized the importance of the role of
underwriters and other monitors in the offering process by
including them in the group of persons potentially liable for
omissions or misstatements in registration statements. As Milton
Cohen stated, the liability provisions have "had the in terrorem
effect of creating an extraordinarily high sense of care and
responsibility in the preparation of registration
statements."-[99]- Consequently, the Committee believed
that Section 11 should continue to be applied under a company
registration system in a manner similar to its current
application.-[100]-
---------FOOTNOTES----------
-[98]-(...continued)
litigation costs if the court determines the suit
or defense to be without merit and the difficulty
faced by purchasers in the open market of tracing
the securities back to the registration statement
in question act as an impediment to Section 11
suits. See Edward F. Greene, Determining the
Responsibilities of Underwriters Distributing
Securities Within an Integrated Disclosure System,
56 Notre Dame L. Rev. 755, 770 n.90 (1981).
-[99]- Cohen, supra n.2, at 1355.
-[100]- It also has been suggested that the Committee
should urge the Commission to express disagreement
with the well-established policy against
indemnification of underwriters for Section 11
liability, at least in the context of shelf and
(continued...)
==========================================START OF PAGE 91======
2. Preservation and Expansion of Statutory Liability
During the pilot stage, purchasers in offerings by
registered companies would have recourse pursuant to Section 11
to the same extent as under the current liability system.
Issuers, officers, directors, experts, and underwriters would be
subject to Section 11 liability for false or misleading
statements in the Form C-1, including all incorporated
information filed in Exchange Act reports. Indeed, for those
issuers that elect to take full advantage of the system and
register all of their securities issuances, the Section 11 remedy
would be available to purchasers in private placement
transactions that otherwise would be exempt under the current
system. Similarly, U.S. purchasers of securities initially
issued overseas in offerings that today would qualify for the
Regulation S safe harbor, would under full company registration
have Section 11 remedies against the issuer to the extent the
flowback is registered and the U.S. purchaser can trace the
purchased securities back to the company registration statement.
Moreover, again under full company registration, because all
---------FOOTNOTES----------
-[100]-(...continued)
company registration offerings. See Documents for
Advisory Committee Meeting, November 21, 1995, Tab
E (Letter dated November 2, 1995 from the
Securities Industry Association to the Advisory
Committee at 9-10) (the "SIA Letter"). The
Committee has determined to make no recommendation
either way concerning this issue. The current
statutory provision for contribution, however,
provides in essence for economic indemnification
with respect to almost all of a potential claim
against an underwriter.
==========================================START OF PAGE 92======
affiliate resales (except those that continue to be effected
under Rule 144) are registered on the Form C-1 rather than sold
in exempt transactions, Section 11 liability would apply with
respect to each such sale. Likewise, broker-dealer underwriting
firms participating in a registered company's offering would
remain subject to Sections 11 and 12(a)(2) liability.
In addition, under the shelf registration system, issuers
may provide transactional disclosure, including material updating
information, in a prospectus supplement rather than by means of a
filing included in the registration statement. As a result,
investors are denied the core protections of Section 11 regarding
such information. As the Commission has noted, "Section 11
ordinarily does not apply to statements omitted from an effective
registration statement and subsequently disclosed in a prospectus
or prospectus supplement, rather than a post-effective
amendment."-[101]- The pilot will make Section 11 more
effective than today (both for company registration and shelf
offerings, if the Form 8-K requirement is extended to the shelf),
since the transactional information disclosed in a Form 8-K filed
at the commencement of non-de minimis equity offerings must be
---------FOOTNOTES----------
-[101]- Elimination of Certain Pricing Amendments and
Revision of Prospectus Filing Procedures,
Securities Act Rel. 6672 (Oct. 27, 1986) [51 FR
39868 (November 3, 1986)]. But cf. Shaw v.
Digital Equipment Corp., 82 F.3d 1194 (1st Cir.
1996) (though not discussing issue, allowing
Section 11 (along with Section 12(a)(2)) claim
predicated on prospectus supplement on motion to
dismiss).
==========================================START OF PAGE 93======
incorporated into the registration statement and thus would be
covered by Section 11.-[102]- In addition, the
opportunity to avoid preparing and delivering a separate
prospectus by incorporating by reference into sales literature or
the confirmation of sale, transactional information filed in an
Exchange Act report will provide an incentive for issuers to file
that information on a Form 8-K, even when not required. In
connection with further implementation of the company
registration system, including extending the system to a broader
class of issuers, the Commission could consider whether it is
necessary to extend full Section 11 liability to the information
provided at the time of an offering under the company
registration system, regardless of whether filed with the
Commission on a Form 8-K or in a prospectus supplement delivered
to investors.
With respect to Section 12(a)(2), some have expressed the
view that one of the reasons companies may choose to raise
capital in the private markets is the differential liability
---------FOOTNOTES----------
-[102]- Reports filed under the Exchange Act automatically
become part of the registration statement and thus
are subject to Section 11 liability. See Wielgos
v. Commonwealth Edison, 688 F.Supp. 331, 338-40
(N.D. Ill. 1988). However, unless the information
represents a fundamental change in the information
previously provided in the registration statement,
the report will not have the legal effect of a
post-effective amendment or a new registration
statement or change the effective date for
liability purposes. See Regulation S-K Item 512(a)
[17 C.F.R. 229.512(a)]; Irving Bank Corp. v. Bank
of N.Y. Co., Inc., 692 F. Supp. 172, 176-80
(S.D.N.Y. 1988).
==========================================START OF PAGE 94======
standards between the negligence standard of liability in Section
12(a)(2) and the strict liability standard of Section
11.-[103]- After Gustafson, it would appear that only
Rule 10b-5 liability may attach to private placements, although
it is unclear what impact the decision will have on the number or
dollar volume of private placements.
The Committee believes that Rule 10b-5 liability will
continue to provide significant deterrence to fraud in private
placements,-[104]- and that Section 12(a)(2) should
continue to be applied as under current law. To the extent an
issuer chooses to register transactions under company
registration that otherwise would qualify as exempt private
placements, the effect of the Gustafson decision on the
applicability of Section 12(a)(2) should be minimized since both
---------FOOTNOTES----------
-[103]- Gustafson v. Alloyd Co., 115 S.Ct. 106 (1995).
Prior to Gustafson, most practitioners and the
Commission believed that Section 12(a)(2)
liability applied to secondary market transactions
and exempt offerings. As a result, due diligence
for private offerings tended to be as extensive as
it is for public offerings (see, e.g., Robert F.
Quaintance Jr., Getting Comfortable with 'Public-
Style' Rule 144A Offerings', INSIGHTS, September
1993, at 8). In its extreme application,
Gustafson would mean that Section 12(a)(2) does
not apply to private placements. As a result,
although underwriting techniques in the Rule 144A
market closely resemble that of a public offering,
including the absence of negotiations and an
opportunity for individual due diligence,
purchasers would not receive any of the statutory
protections of a public offering.
-[104]- Transcript of September 29, 1995 Advisory
Committee Meeting at 27-29 (statements of Mr.
Sonsini).
==========================================START OF PAGE 95======
Section 11 and Section 12(a)(2) would be applicable. In
addition, to the extent that an issuer chooses to use selling
materials as the statutory prospectus by incorporating filed
information from the Form 8-K, Section 12(a)(2), rather than Rule
10b-5, would apply to those selling materials.
B. Due Diligence Under Company Registration
The Commission's development of the integrated disclosure
system over the last decade and a half has shifted the primary
source of key disclosures concerning the company from the
sporadic or infrequent disclosures contained in public offering
documents under the Securities Act to the updated reservoirs of
information regarding a company contained in Exchange Act
reports. The gatekeepers have tried to adapt to these changes
since the inception of the integrated disclosure system. The
underwriter community, in particular, has voiced longstanding
concerns regarding the impact of these reforms on traditional due
diligence functions.-[105]- The Committee is
cognizant of the concerns raised by underwriters and outside
directors that market changes have altered the dynamics and
---------FOOTNOTES----------
-[105]- See SIA Letter, supra n.100 (recommending that the
Committee and the Commission consider recommending
amendments to Section 11 with respect to
underwriters to eliminate the requirement that, in
establishing their due diligence defense, they
prove that they made a reasonable investigation);
see also American Bar Association Committee on
Federal Regulation of Securities, Report of the
Task Force on Sellers' Due Diligence and Similar
Defenses Under the Federal Securities Laws, 48
Bus. Law. 1185 (May 1993) (the "ABA Due Diligence
Report").
==========================================START OF PAGE 96======
nature of their relationships with issuers and, consequently,
their traditional due diligence functions. In particular, the
Committee acknowledges that the tightened time constraints may
make it more difficult for underwriters and outside directors to
discharge their due diligence obligations. In order to protect
investors by maintaining the integrity of the disclosure system,
the Committee has concluded that continued emphasis on the due
diligence obligations of underwriters and outside directors is
critical to maintaining and increasing investor protection.
Moreover, between the choices of simply limiting liability for
participants versus providing reasonable procedures so that
participants can better perform their due diligence obligations
and, therefore, as a practical matter limit their exposure by
reducing the opportunity for material misstatements to be
disseminated to the public, the Committee strongly prefers the
latter.
Following the lead of the ABA Task Force appointed to study
due diligence practices under integrated disclosure and shelf
registration,-[106]- the Committee determined that, rather
than excusing monitors from their due diligence responsibilities,
more guidance regarding their respective responsibilities should
be furnished by the Commission. The Committee recommends
providing additional guidance, within the framework of current
Commission Rule 176, that would elaborate upon the factors courts
---------FOOTNOTES----------
-[106]- See ABA Due Diligence Report, supra note 105.
==========================================START OF PAGE 97======
may consider as indicia of "reasonable investigation" and/or
"reasonable care" for purposes of determining whether the
particular defendant has met its due diligence obligations under
Sections 11 and 12(a)(2) in the context of an offering made under
the company registration system.-[107]- The Committee
determined not to recommend that additional Commission guidance
regarding the due diligence function take the form of a safe
harbor from liability or an evidentiary presumption. The
Committee agrees with the district court in Escott v. BarChris,
which stated that "[i]t is impossible to lay down a rigid rule
suitable for every case defining the extent to which such
verification must go. It is a question of degree, a matter of
judgment in each case."-[108]-
To the extent changes in the offering process require
greater reliance on other gatekeepers in order to deter fraud and
provide incentives for the highest quality disclosures, the
Committee believes that underwriters and outside directors should
---------FOOTNOTES----------
-[107]- The ABA Due Diligence Report recommends extension
of Rule 176's enumeration of "relevant
circumstances" to an underwriter's or agent's
exercise of "reasonable care" under Section
12(a)(2). See id.
Notably, Section 12(a)(2) does not refer to the need for a
"reasonable investigation," and consequently raises the
question about whether Congress intended to require a lesser
standard of care. For a discussion of legislative history
and case law on whether different levels of due diligence
are required, see id. at 1190.
-[108]- Escott v. BarChris Construction Corporation, 283
F. Supp. 643, 697 (S.D.N.Y. 1968).
==========================================START OF PAGE 98======
be able to take the efforts of those other persons into account
in evaluating the appropriate due diligence they should perform
at the time of the offering. This facts and circumstances
approach to due diligence was embraced by the Commission when it
adopted Rule 176 in response to identical concerns raised by the
underwriting community and others when the integrated disclosure
system was implemented in 1982:
For example, the Commission believes that a court would not
expect the investigation undertaken in connection with a
short form registration of a seasoned company to be the same
as that which would be reasonable in connection with an
initial public offering.-[109]-
Under the recommended approach, as under current Rule 176,
persons who are eligible for the due diligence/reasonable care
defenses codified in Sections 11 and 12(a)(2), respectively,
could consider the due diligence inquiries of those persons in
the best position on an ongoing basis to oversee the quality and
accuracy of the requisite disclosure in determining the degree of
due diligence investigation they themselves need to perform to
satisfy their statutory obligation. As under current Rule 176,
the factors are meant to be illustrative, not exhaustive, and the
weight given to each factor necessarily must vary with the facts
and circumstances of a particular offering, including whether the
offering is a routine financing, or involves equity or debt. As
outlined below, this guidance should create incentives for those
---------FOOTNOTES----------
-[109]- Securities Act Release No. 6383 (March 3, 1982),
note 101 [47 FR 113800, 11400 n.101]; SIA Letter,
supra n.100, at 9.
==========================================START OF PAGE 99======
engaging in due diligence to make better use of others who are in
a position to help ensure the quality and integrity of the
disclosure -- to the ultimate benefit of investors.
The Committee believes SAS No. 71 interim financial reviews
by the company's outside auditor to be particularly relevant in
this context.-[110]- By recognizing the appropriateness
of an underwriter's and outside director's reliance on those
reviews in discharging their due diligence duties, the Commission
will encourage registered companies to involve this outside
monitor more extensively and on a more continuous basis with
unaudited information. As a result, widespread use of interim
reviews should increase investor confidence in the quality of
quarterly reporting.
Comfort letters provided by the company's outside auditing
firm to the underwriters in accordance with SAS No. 72 also may
be relevant. Although the legal effect of an auditor's comfort
letter necessarily varies with the audited or non-audited
character of the underlying financial information, and the letter
alone normally will not be determinative of whether a reasonable
investigation was conducted, such a letter nevertheless adds
important independent oversight of the issuer's financial
reporting in connection with an offering. Consequently, the
receipt of a comfort letter appropriately should be recognized as
a factor to be weighed in evaluating how a gatekeeper must
---------FOOTNOTES----------
-[110]- See supra pp. 24-28.
==========================================START OF PAGE 100======
perform its due diligence in order to discharge its
responsibilities under all the relevant facts and circumstances.
1. Underwriters
Although underwriters would not be relieved of
responsibility for the accuracy and completeness of the issuer's
disclosure, their review at the time of the offering should be
facilitated by the continuous review conducted by other monitors
as well as the enhanced disclosure practices recommended by the
Committee.-[111]- This assistance would be in addition to
the other recommendations of the Committee, such as the filing of
a Form 8-K at the time of the offering, that are intended in part
to facilitate the underwriter's due diligence review at the time
of most equity offerings.-[112]- The underwriters'
ability to confer with other persons familiar with the issuer as
well as with management to assess the scope of their review
preserves the underwriters' central, independent role in ensuring
the quality of disclosures regarding the securities they bring to
market. Accordingly, the Committee determined that (in addition
to the factors in the current Rule 176) the relevant factors to
be considered in connection with the underwriter's due diligence
defense should include the following:
(i) The Senior Management Certifications (described
above);
---------FOOTNOTES----------
-[111]- Transcript of September 29, 1995 Advisory
Committee Meeting at 189-194 (statements of Mr.
Sutton and Mr. Elliott).
-[112]- See supra p. 23-24.
==========================================START OF PAGE 101======
(ii) The Management Report to the Audit Committee
(described above);
(iii) Whether other outside professionals have
reviewed the relevant documents, for example,
pursuant to a review of the issuer's interim
financial statements by the company's
auditors in accordance with SAS No. 71, the
performance of procedures with respect to
events subsequent to the date of the audited
financial statements in accordance with SAS
No. 37, and the receipt of a "comfort letter"
under SAS No. 72, or whether the board or a
committee of the board received a Rule 10b-5
opinion letter from counsel regarding the
non-financial and non-expertized portions of
the periodic reports;
(iv) The extent of the underwriter's access to their
own or outside analysts that have followed the
issuer for a significant period of
time;-[113]-
(v) Whether a board disclosure committee was appointed
and the quality of the review engaged in by the
disclosure committee; and
(vi) The size of the offering, both in absolute and
relative terms, vis-a-vis the size of the issuer.
Ultimately, however, underwriters bringing offerings to
market will continue to have significant responsibility for the
disclosures used in connection with that offering. Even apart
from the potential for civil liability under Sections 11 and
12(a)(2), an underwriter has a legal obligation under the
antifraud provisions of the federal securities laws to have a
---------FOOTNOTES----------
-[113]- See Circumstances Affecting the Determination of
What Constitutes Reasonable Investigation and
Reasonable Grounds for Belief Under Section 11 of
the Securities Act; Treatment of Information
Incorporated by Reference Into Registration
Statements, Securities Act Rel. 6335 (Aug. 6,
1981) [46 FR 42015 (August 18, 1981)].
==========================================START OF PAGE 102======
reasonable basis for its recommendations and its belief in the
accuracy of the statements contained in the offering
materials.-[114]- As a result, notwithstanding the
comfort afforded by the proposed guidance regarding the due
diligence defense, the underwriter must take care to ensure that
it has performed all the procedures and investigations necessary
to form a reasonable basis for its belief regarding the accuracy
and adequacy of the issuer's disclosures.
2. Outside Directors
Certain Committee members expressed particular concern about
exposing outside directors to greater liability under the company
registration system.-[115]- The Committee believes that
outside directors of public corporations currently are not always
properly positioned to perform a full investigative function.
For example, because of timing constraints characteristic of
shelf takedowns, outside directors may not have sufficient time
---------FOOTNOTES----------
-[114]- See In re Donaldson, Lufkin & Jenrette Securities
Corporation, Securities Act Rel. 6959 (Sept. 22,
1992); Justin Klein, Underwriter Beware: SEC
Brings Proceeding for Failure to Conduct Adequate
Due Diligence, INSIGHTS, March 1993, at 17. See
also Exchange Act Rule 15c2-12 (Municipal
Securities Disclosure) [17 C.F.R. 240.15c2-12];
Municipal Securities Disclosure, Exchange Act Rel.
26100 (September 22, 1988) [53 FR 37778 (September
28, 1988)]; Municipal Securities Disclosure,
Exchange Act Rel. 26985 (June 28, 1989) [54 FR
28799 (July 10, 1989)].
-[115]- See, e.g., Transcript of July 26, 1995 Advisory
Committee Meeting at 247-52 (statements of
Professor Coffee); Concurring Statement of John C.
Coffee, Jr., Edward F. Greene and Lawrence W.
Sonsini.
==========================================START OF PAGE 103======
to review any disclosure documents other than the Form 10-Ks.
Frequent, repetitive equity takedowns, such as those effected
pursuant to the at-the-market provisions of the shelf rules, may
pose difficult problems for outside directors.-[116]- The
potential extension of director liability under Section 11 to
transactions that today would be conducted as exempt private
placements could exacerbate those concerns for outside directors.
Outside directors, however, also are almost uniquely
positioned to maintain continuous oversight of the company's
disclosures, provided a practical mechanism were established to
permit them to do so. The audit committee is an obvious example
of such an initiative to formalize the role of outside directors.
The Committee sought similar approaches to strengthen the role of
outside directors in the disclosure process in order to ensure
that the promise of appropriate outside director gatekeeping
could be realized. As discussed previously, the establishment of
a disclosure committee would provide such a formal mechanism for
outside directors to accomplish that goal. The Committee also
believes that the outside directors, like the underwriters,
should be able to consider management certifications and reports,
and the preparation or review of relevant documents by various
independent professionals, in determining the appropriate level
of due diligence necessary to satisfy the directors' statutory
obligation. Specifically, the Committee determined that, in
addition to the factors in current Rule 176, the relevant factors
---------FOOTNOTES----------
-[116]- See n. 79 to Appendix A to the Report.
==========================================START OF PAGE 104======
that courts should consider in connection with an outside
director's establishment of a due diligence defense should
include, but not be limited to, the following:
(i) The Senior Management Certifications (described
above);
(ii) The Management Report to the Audit Committee
(described above); and
(iii) Whether outside professionals have reviewed
the relevant documents, for example, pursuant
to a review of the issuer's interim financial
statements by the company's auditors in
accordance with SAS No. 71 and a "comfort
letter" under SAS No. 72, or whether the
board or a committee of the board received a
10b-5 opinion letter from counsel regarding
the non-financial and non-expertized portions
of the periodic reports.
C. Conclusion
The Committee has determined to preserve, and in the case of
all non-de minimis equity offerings expand, the current Section
11 and 12(a)(2) liability scheme and to provide additional
guidance regarding due diligence defenses. The pilot gives the
Commission a meaningful opportunity to test the company
registration system while monitoring the effects on participants
of continued exposure to current standards of liability. If
experience with the pilot demonstrates that more concrete
guidance is appropriate, the Commission could consider further
measures in connection with steps towards final implementation of
the company registration system. The Committee thus encourages
the Commission during the pilot stage to monitor the due
diligence practices that evolve generally from the use of company
registration, and specifically from the application of the new
==========================================START OF PAGE 105======
guidance, and to evaluate the consequences for due diligence and
investor protection.
==========================================START OF PAGE 1======
SECURITIES AND EXCHANGE COMMISSION
ADVISORY COMMITTEE ON
THE CAPITAL FORMATION AND REGULATORY PROCESSES
TERM SHEET FOR PILOT
COMPANY REGISTRATION SYSTEM
Goals
The goals of the company registration system are to:
(i) maintain and enhance the protection of investors in the
primary markets;
(ii) eliminate unnecessary regulatory costs and
uncertainties that impede a company's access to capital;
(iii) eliminate complexities arising from the need to
distinguish between public and private, domestic and
offshore, and issuer and non-issuer transactions; and
(iv) enhance the level and reliability of disclosure
provided to investors in the secondary markets on an ongoing
basis, not just when the issuer conducts a public offering.
Concept
Registration is company, not transaction-based (except for
IPOs and other specific transactions). Once meeting
eligibility standards, companies register with the SEC and
file periodic reports. Routine financings, as well as
resales by affiliates and resales of what are currently
known as restricted securities, could be consummated without
the current SEC review and registration process.
Information provided to investors in the marketing of these
routine financings would be based on what the market demands
and on company and transactional information required to be
filed as part of the issuer's periodic reports. The
principal distinctions currently existing between public and
nonpublic offerings by registered companies (with the
resultant formalities and restrictive concepts such as gun-
jumping and integration) would be eliminated, because offers
and sales by companies already registered with the SEC
generally would not be subject to additional transactional
registration requirements.
==========================================START OF PAGE 2======
Essential Elements of the Pilot System
1. Disclosure
(a) Company Registration Statement An eligible company may
file a Form C-1 registration statement disclosing plans to
make offerings from time to time on a company-registered
basis and registering all sales of all securities.-[1]-
Form C-1 generically registers the types of securities and
offerings (including resales by affiliates and statutory
underwriters, see Section 1(e) below) that are contemplated
and incorporates all existing and future periodic reports.
Certain exemptions or exclusions from the registration form
would be available (see Section 3(b) below). Amendments can
be filed to reflect changed plans as appropriate (e.g.,
where a company changes the manner of financing or amends
its charter to authorize a new class of securities). The
Form C-1 registration statement also is updated
automatically by each filing under the Exchange Act. Only a
nominal registration fee would be paid at the time of
filing, with the issuer undertaking to pay a fee upon the
sale of securities (i.e., pay as you go).-[2]-
---------FOOTNOTES----------
-[1]- A company could effect its transition to the
company registration system from the current
system simply by electing to be governed under and
complying with the company registration system
requirements. To the extent the company currently
has restricted securities outstanding, the company
could elect, as part of its transition to a
company registration system, to register any or
all of its outstanding restricted securities for
resale on the Form C-1 (and pay the applicable fee
and execute a qualified indenture in the case of
debt securities at that time) or merely allow the
restricted securities to retain that status until
the expiration of the Rule 144 restricted periods
(three years, but recently proposed to be
shortened to two years; limited resales allowed
after two years, recently proposed to be shortened
to one year).
-[2]- There are various mechanisms to achieve this
result within the current statutory framework:
Once the Form C-1 has becomes effective, it could
serve as an evergreen registration statement for
offers and sales of securities. Alternatively,
the effective date of the Form C-1 with respect to
a specific offering could be delayed until an
(continued...)
==========================================START OF PAGE 3======
(b) File and Go Sales could be consummated upon the
filing with the Commission of disclosure regarding the
specific offering of securities and the payment of a
transaction-based fee. (Prospectus delivery requirements
---------FOOTNOTES----------
-[2]-(...continued)
amendment is filed regarding that transaction.
Another alternative would be to have the Form C-1
go effective upon filing, but require another
abbreviated registration statement to be filed at
the time of the transaction. In any case, the
Form C-1 could serve as the basis for multiple
offerings, applicable statutes of limitation
periods would run commencing from the time of
sales made under the form, and the fee would be
paid at the time of the particular sale.
==========================================START OF PAGE 4======
are discussed below.) The transactional information would
consist of the following, to the extent material and
otherwise not previously disclosed:
description of securities/pricing
plan of distribution, experts, and underwriter
information
summary financial and dilution information/pro formas
actual use of proceeds
risk factors
material changes
Thus, at least the same level of public disclosure on file
with the Commission concerning registered offerings that
currently exists today for seasoned issuers would be
maintained under a company registration scheme.
The manner in which the transactional information could be
filed with the Commission will depend on the nature of the
offering. In equity offerings (including offerings of
convertible debt and warrants) over the specified threshold
(e.g., 3 percent of public float), the issuer would file a
Form 8-K, which would be incorporated into the
registration statement. The Committee recommends that this
requirement apply to non-de minimis equity shelf offerings
by non-company registrants as well. The purpose for the
Form 8-K filing is to facilitate due diligence inquiries by
underwriters and other offering participants, and to ensure
full coverage of Section 11 statutory liability to this
information, which would automatically be incorporated into
the registration statement. The Form 8-K would be filed a
reasonable time in advance of the offering (as specified by
Commission rule, e.g., one to three business days), where
necessary to provide the market with adequate notice of
material developments. The transactional information need
not be filed on a Form 8-K until the time of the
offering.
With respect to all other offerings, the issuer will have a
choice regarding the manner in which the transactional
disclosure will be filed with the Commission. The issuer
could voluntarily file a Form 8-K, as described above;
alternatively, the issuer could merely file the prospectus
supplement containing the required information when that
information is delivered to investors. The information
contained in the prospectus supplement normally would not be
part of the registration statement. This latter method of
filing is consistent with practice under shelf registration
today. Neither the Form 8-K nor the prospectus supplement
normally would be subject to prereview prior to the
commencement of the offering.
==========================================START OF PAGE 5======
Consistent with current practice relating to shelf
offerings, information representing a fundamental change in
the information regarding the issuer previously disclosed by
the issuer would be made by an amendment the Form C-1 or by
a Form 8-K or other Exchange Act filing; a prospectus
supplement disclosing the fundamental change alone would not
suffice. Other types of material developments, however,
could be provided either in the Form 8-K Exchange Act filing
prior to the offering or as part of the prospectus
supplement, as described above. In either case, the
issuer's public disclosures must be current at the time of
the offering.
(c) Auditor's Consent Consistent with current practice
under the shelf registration system, an auditor's consent
would not have to be filed with each sale or takedown off
the company registration statement. An auditor's consent to
the use of its report would be dated as of or shortly before
the effective date of the registration statement (as updated
for the filing of audited financial statements on Form 10-K
or other fundamental changes) and would have to be on file
at the time of the offering. The auditor could consent to
incorporation of its audit report into the company
registration statement at the time the Form 10-K containing
its audit report is filed by including a currently dated
consent in the Form 10-K. That consent (as of the
registration statement's effective date), unless withdrawn
by the auditor, would be applicable to all offerings
pursuant to the Form C-1 until the issuance of a new set of
audited financial statements or other fundamental changes
that update the effective date of the registration
statement. Alternatively, the consent could be filed and
currently dated for a specific issuance of securities or
conditions could be attached to its use.
(d) Prospectus Delivery Delivery of the transactional
information could be accomplished either by incorporation by
reference or by actual delivery, depending on the size of
the offering and other factors. The prospectus would not be
subject to prior staff review except in the case of
"extraordinary securities transactions," as defined below.
These different levels of transactions essentially fall into
three tiers:
Tier One: In "routine" transactions, an issuer could
incorporate information contained in the Form C-1
registration statement and filed reports,
including the transactional information filed on a
Form 8-K, into a document serving as the
prospectus, such as the confirmation or selling
materials, that is then distributed to investors,
==========================================START OF PAGE 6======
thereby satisfying in any of these cases the
prospectus delivery requirement.
Any material company developments to be
incorporated must be filed on the Form 8-K a
reasonable time prior to the dissemination of the
prospectus incorporating the information (e.g.,
one to three business days) to provide the market
an opportunity to absorb the information.
Otherwise, as today, the information must be
delivered physically as part of the formal
prospectus, which is filed simultaneously with the
Commission.
Tier Two: In "nonroutine" transactions, the issuer would be
required to prepare and deliver a formal
prospectus containing transactional and, where
appropriate to update disclosures, company
information. The prospectus would be filed (in
addition to or as part of the mandated Form 8-K in
non-de minimis equity offerings) with, but would
not be subject to registration or prior review by,
the SEC.-[3]- Information previously provided
in selling materials or in a formal prospectus
need not be redelivered.
Nonroutine transactions would consist of any
single transaction increasing, or potentially
increasing, the issuer's outstanding voting
securities by more than 20%. The Commission could
adopt a similar standard for offerings of other
equity and senior securities.
The offering of a new class of securities would
require actual delivery of information specific to
that security (e.g., terms and description of the
security, investment risks specific to that
security).
Actual delivery of information generally of
interest only to purchasers in the offering and
not the market (such as underwriter discount
information or security specific information)
could be provided as part of the confirmation.
---------FOOTNOTES----------
-[3]- However, other than in the case of underwritten
offerings for cash, exchange listing requirements
would require shareholder approval of these
offerings, thus creating an opportunity for SEC
review of the disclosure materials under the proxy
rules.
==========================================START OF PAGE 7======
In those cases where formal prospectus delivery is
mandated, the prospectus must be delivered prior
to the investors agreement to purchase.
To the extent written selling materials that do
not satisfy prospectus disclosure requirements are
distributed to investors in the course of the
offering, a prospectus containing the mandated
information would have to be delivered prior to or
simultaneous with the selling materials,
consistent with current statutory and regulatory
requirements. An issuer could avoid delivery of a
statutory prospectus by either including or
incorporating the required information into the
selling materials and treating the selling
materials as the statutory prospectus. That
approach, however, would subject those materials
to liability under Section 12(2) of the Act.
Actual delivery of the prospectus information
would not be required in the case of sales to
accredited investor purchasers, with the
expectation that these investors will demand the
information they require. This would be
consistent with the requirements under Regulation
D and Rule 144A today.
Tier Three: In "extraordinary transactions," a post-
effective amendment to the Form C-1 would be
required and would be subject to SEC staff
review of the transactional information. The
same prospectus delivery requirements as in
Tier Two transactions would apply.
These transactions would include any financing,
merger, material acquisition or other
restructuring transaction involving a company's
issuance of securities that results in an
increase, or potential increase, of at least 40%
of the outstanding voting securities.
(e) Affiliate and Underwriter Sales In cases where all
sales by an issuer are registered on the Form C-1, there is
a far reduced concern about the potential use of conduits as
a means to distribute unregistered shares into the market.
Accordingly, in the case where an issuer elects to cover all
sales under the company registration statement, a more
==========================================START OF PAGE 8======
narrow application of the registration and resale
requirements would apply.-[4]-
The class of persons subject to the affiliate resale
limitations would include only the CEO and inside
directors and, as a rebuttable presumption, perhaps
holders of 20% of the voting power, or 10% of the
voting power with at least one director representative
on the board, and any representatives of such holders.
These affiliates could continue to sell without
registration under the existing provisions in Rule 144
for affiliate sales. Sales by these affiliates
exceeding the Rule 144 limits would be registered as
resales under the Form C-1. An issuer could control
the sales of affiliates by declining to file a
prospectus supplement or a Form 8-K to complete the
registration process at the time of the secondary
offering (just as an issuer can refuse to grant
registration rights under the current system).
Significant shareholders could resell without
restrictions if they can rebut the presumption of
control arising from their holdings. Contractual
resale restrictions also would provide a means for an
issuer to control resale activities of its insiders and
significant shareholders.
Resales by statutory underwriters for issuers and
affiliates would be registered under the Form C-1. A
statutory underwriter for the purpose of offerings
registered under the Form C-1 would consist of a person
engaged in the business of a broker-dealer (regardless
of whether or not registered as such) acting on behalf
of an issuer or affiliate in a distribution.
2. Eligible companies
The system would be phased in and made available on an
experimental basis. The pilot would be voluntary; eligible
companies could elect to opt in as desired. It would begin
with larger, more seasoned issuers eligible to elect to be
covered. Once the election is made, a company can opt out
---------FOOTNOTES----------
-[4]- An issuer also may elect to maintain the current
private placement exemption for sales of equity
securities (see Section 3(b)(iii) below). If an
issuer elects to maintain such exemption, the
current applicability of the affiliate and
statutory underwriter resale limitations, as
opposed to the narrower approach as described
herein, would continue to apply.
==========================================START OF PAGE 9======
by withdrawing the Form C-1, but would not be eligible to
use the Form again for a period of two years. During the
pilot stage, eligibility would be limited to a senior class
of S-3 companies-[5]- that have a
(a) Public float of $75 million;
(b) Reporting experience of two years; and
(c) NYSE, Amex or NMS listings.
This final requirement would provide the benefit:
(i) of adding an overlay of listing standards,
including the agreement to provide prompt
disclosure of material developments; and
(ii) of minimizing the amount of coordination with
the states necessary to implement the pilot
stage due to the common Blue Sky exemption
for offerings by listed companies.
These standards collectively reduce the number of companies
eligible to use the Form C-1 during the pilot stage to
approximately 30% of public companies.
A subsidiary of an eligible company could issue debt that is
guaranteed in full by the parent under the parent's Form C-
1.
Closed-end investment companies would not be eligible.
Foreign issuers would be eligible for the pilot if they
undertake to file the same forms and meet the same
requirements as domestic companies. The Commission should
consider whether reconciled interim financials filed on Form
6-K on a semi-annual basis should suffice (this is the
current practice for foreign issuers using the shelf on Form
F-3).
To be eligible, issuers must undertake to adopt measures
that would enhance secondary market disclosure (as discussed
below in Section 4). Noncompliance with the conditions as
of the time of the Form 10-K update would result in the loss
of eligibility (for two years) to make offerings pursuant to
---------FOOTNOTES----------
-[5]- S-3 companies generally include only those that
have a $75 million public float; one-year
reporting history; and are current with respect to
their reporting requirements and certain fixed
obligations.
==========================================START OF PAGE 10======
the Form C-1. In addition, the issuer must be current with
respect to its Exchange Act filing obligations before
commencing an offering off the Form C-1.
Eventually, the system would be made available to all
publicly held companies (that have engaged in an IPO), but
with additional enhancements or conditions, including
prospectus delivery, pre-sale notice or filing requirements,
prereview annual financial information, etc.
3. Transactions Covered
As noted, the Form C-1 registration statement would register
all sales of all securities made by the issuer or its
affiliates (subject to exceptions and exclusions as
discussed below, see in particular Section 3(b)
below).-[6]- Since sales made subject to the Form C-1
would be registered, the securities would be freely
tradeable.
Thus, under the proposed system, registered companies
would waive transactional exemptions such as those for
private offerings (4(2), and Reg. D (Rules 505 and
506)), intrastate offerings (3(a)(11) and Rule 147),
issuer exchange offers (3(a)(9)), and transactions
pursuant to fairness hearings (3(a)(10)).-[7]-
The inclusive nature of the Form C-1 registration
statement ensures that issuers could not use conduits
to avoid liability that results from registration of
securities. Treating all sales as registered generally
eliminates the need for concepts of restricted
securities, integration, general solicitation,
flowback, etc., with respect to securities issued by
companies opting into the system.
Where an issuer is not prepared to disclose publicly a
material development or other material information that
would otherwise be required to be disclosed in a registered
offering, the issuer still can sell pursuant to the Form C-1
by providing the information to the purchaser(s) on a
---------FOOTNOTES----------
-[6]- To the extent relevant during the transitional
stages, secondary offerings of restricted
securities by existing security holders could be
made pursuant to the system as well.
-[7]- It may be necessary to preserve the Section
3(a)(10) exemption for involuntary distributions
pursuant to court orders, such as settlements of
class actions.
==========================================START OF PAGE 11======
confidential basis with a lock-up agreement. The Commission
would provide a full or partial exemption from its filing
requirements for these limited placements if made to
sophisticated investors, and accompanied by measures to
ensure that those securities are not traded until full
disclosure is provided to the public (as would be necessary
under Rule 10b-5).
In this manner, once the issuer makes public disclosure of
the otherwise confidential information or the information is
no longer material, the purchaser would have freely
tradeable securities without any additional holding period
or registration requirements. In addition, unlike an exempt
offering, the liability provisions of the Securities Act
would attach to the securities originally issued in the
limited offerings.
==========================================START OF PAGE 12======
(a) Exclusions:
(i) IPOs: Only companies that have conducted a
registered public offering of debt or equity would
be eligible to use the company registration form.
(ii) Complex securities not valued on the basis of the
issuing company's business and financial
information, such as asset backed or special
purpose issuers. Complex securities that are
valued in part on the basis of the issuer's
performance, such as structured securities or
tracking securities (e.g., GM Series H) could be
made eligible subject to special disclosure
requirements.
(iii) Exempt securities such as commercial paper
and bank guaranteed debt.
(b) Voluntary Exclusions:
(i) Offshore offerings of any securities to non-U.S.
persons could be excluded from the Form C-1.
However, equity securities would be registered
(and a fee paid with respect thereto) on the Form
C-1 for purposes of any resales of the securities
into the United States as a result of flowback
transactions (the fee would be based upon the
amount reasonably estimated to flow back into the
United States; thus, U.S. purchasers of equity
securities initially offered overseas would
benefit from the statutory protections to the same
extent as if the securities were initially sold in
the United States. The statute of limitations
would run from the time of the initial overseas
sale by the issuer.
(ii) Placements of non-convertible debt to
institutional investors could be excluded from the
Form C-1.
(iii) Modified Company Registration -- "Company
Lite" The issuer could elect a modified form
of company registration that would continue
to permit private placements of any of its
securities, including equity securities, as
well as reliance on the other transactional
exemptions.
So long as the issuer undertakes to adopt the
enhanced disclosure practices, the issuer would
==========================================START OF PAGE 13======
have the benefits of the file and go registration
process for its public offerings, the payment of
filing fees at time of sale, and most of the other
benefits of company registration. Exempt sales
would not be integrated with registered sales made
pursuant to the Form
C-1.
However, the securities sold in the private
placement would be restricted securities subject
to current holding periods and resale limitations.
In addition, the new, limited application of
affiliate resale restrictions would not apply to
securities sold by that issuer -- the current
restrictions on affiliate resales would continue
to apply. Likewise, the statutory underwriter
concept for resale purposes would not be limited
to broker-dealer firms in connection with these
private placements. This approach would permit
issuers to weigh the benefits of registration of
all equity sales against the benefits of a
continued private placement exemption, including
the absence of Section 11 liability for sales made
pursuant to such exemption.
4. Disclosure Enhancements
Complementing measures to ease issuer access to the market
would be measures to improve the level and reliability of
secondary market disclosure. The Commission, following the
pilot stage, should consider reviewing the enhancements to
determine whether it would be desirable to make them
applicable to all issuers, or at least those issuers using
the shelf registration procedure, rather than having
separate requirements applicable only to registered
companies.
(a) Top Management Certifications Certification to the
Commission (not a filed document) would be required of
two of the following four officers that they have
reviewed the Form 10-K, the Form
10-Qs and any Form 8-Ks reporting mandated events, but
not for voluntarily filed 8-Ks, and are not aware of
any misleading disclosures or omissions: the CEO, COO,
CFO, or CAO. The attestation would be required upon
the filing of each such document with the Commission.
(b) Management Report to Audit Committee A report
prepared by management and submitted to the audit
committee describing procedures followed to ensure the
integrity of periodic and current reports and, in light
of the new narrow application of affiliate resale
==========================================START OF PAGE 14======
restrictions, procedures instituted to avoid potential
insider trading abuses (e.g., any requirement that
company insiders clear trades with the general
counsel's office). This report would be made public as
an exhibit to the Form 10-K; the report need not be
resubmitted if the described procedures are unchanged.
(c) Form 8-K Enhancements Expansion of current reporting
obligation on Form 8-K under the Exchange Act to
mandate disclosure of additional material developments:
(i) Material modifications to rights of security
holders (current Item 2 of Form 10-Q);
(ii) Resignation or removal of any of top
five executive officers;
(iii) Defaults of senior securities (current
Item 3 of Form 10-Q);
(iv) Sales of significant percentage of the
company's outstanding stock (whether in
the form of common shares or convertible
securities);
(v) Issuer advised by independent auditor that
reliance on audit report included in previous
filings is no longer permissible because of
auditor concerns over its report or issuer
seeks to have a different auditor reaudit a
period covered by a filed audit report.
For the above items that are required now to be filed
on a Form 10-Q, the information therefore would be
provided on a current, rather than a quarterly, basis.
Moreover, the period within which a Form 8-K must be
filed following any mandatory event specified in that
form would be accelerated from 15 calendar days to 5
business days.
(d) Risk Factors Risk factor analysis disclosure
requirements currently required in all Securities Act
filings would be added to the Form
10-K (and would thereby be capable of being
incorporated by reference). The caption could be
modified to be "Significant Considerations in
Connection with Investing in Company Securities,"
instead of "Risk Factors," when the analysis is
presented in the Form 10-K.
==========================================START OF PAGE 15======
(e) Other Action (Voluntary) Companies under the company
registration system also may voluntarily adopt measures
such as the creation of a disclosure committee of
outside directors, and the obtaining of SAS 71 reviews.
Such measures would be included within the list of
relevant factors for assessing the adequacy of due
diligence in current Rule 176 (see below).
==========================================START OF PAGE 16======
5. Liability
Section 11 Liability The issuer would be subject to strict
Section 11 liability to purchasers of securities sold under
the company registration statement for materially false or
misleading information in the Form C-1 (including all
incorporated information such as transactional information
filed as part of the Form 8-K). Officers, directors,
experts and underwriters likewise would be liable for
materially false or misleading statements in the Form C-1
(including the transactional and updating information filed
on the Form 8-K and incorporated into the Form C-1) and any
post-effective amendments thereto (with the due diligence
defenses afforded under current law).
This approach does not represent a change in the liability
system for public offerings (with the exception of sales by
persons who would no longer be subject to resale
restrictions and thus who would not have liability under
Section 11 for their resales), but represents an expansion
of liability to the extent transactions that would otherwise
be exempt private placements or flowback from overseas
placements are covered by the Form C-1. In addition,
because in many offerings the transactional information will
be filed on a Form 8-K and made part of the registration
statement, rather than merely part of a prospectus
supplement as is the practice in shelf offerings today,
Section 11 will apply to that disclosure when it has not
been applicable under the current scheme.
Similar to current law, the Section 11 remedy would
extend to all purchasers of securities sold initially
under the Form C-1 (subject to statute of limitations
and the ability of purchasers to trace securities to
the misleading registration statement). Thus, issuers
and affiliates cannot avoid liability by placing
securities with conduits for resale to the public.
Indeed, sham transactions involving strawmen would be
deemed registered issuer (or affiliate) sales.
Section 12(2) Liability Rather than merely fraud liability,
negligence liability for sellers in public offerings would
apply to any selling materials serving as a statutory
prospectus (i.e., no formal prospectus has been previously
delivered) and incorporated documents (in addition to any
Section 11 liability that might be applicable to those
documents). Likewise, oral communications will continue to
be subject to Section 12(2) liability.
==========================================START OF PAGE 17======
Exchange Act Liability Liability under Sections 18 and
10(b) of the Exchange Act and Rule 10b-5 thereunder, would
remain applicable for material misstatements or omissions in
filed reports or made in connection with the purchase or
sale of securities.
Due Diligence Guidance To provide incentives for the
adoption of improved disclosure practices and to address the
expanded Section 11 liability exposure of officers and
directors of registered companies, guidance setting forth
the criteria for evaluating the adequacy of a non-issuer
defendant's Section 11 due diligence in connection with a
particular offering would be provided. The goal is to
enhance the quality of disclosure and to provide more
meaningful guidance regarding the satisfaction by
underwriters and directors of their ("reasonable
investigation") due diligence responsibilities. Rule 176
currently specifies that a relevant factor is reasonable
reliance on officers, employees and directors whose duties
should have given them knowledge of the facts.
Guidance would be provided to clarify as well the relevant
factors that may be considered when such defendants attempt
to establish a defense of "reasonable care" to a Section
12(2) negligence claim.
(a) Both underwriters and outside directors could take into
account
(i) the certifications of senior management (e.g., CEO,
COO, CAO and CFO) discussed above, and (ii) the
Management Report to the Audit Committee discussed
above.
(b) Underwriters and outside directors also may consider
whether other professionals have reviewed the
documents, such as a review of the issuer's interim
financial statements by the company's auditors in
accordance with SAS 71 or other more detailed
procedures, subsequent event reviews consistent with
SAS 37, and a "comfort letter" under SAS 72, or whether
the board or a committee of the board received a Rule
10b-5 opinion letter from counsel regarding non-
financial and non-expertized portions of the periodic
reports and Form C-1.
Use of these measures by the issuer is voluntary
and the fact that an issuer does not adopt such
practices is not indicative of an inadequate
review by offering participants.
(c) Underwriters also may consider the extent of their
access to analysts (either their own or outside
==========================================START OF PAGE 18======
analysts, and consistent with appropriate "chinese
wall" procedures) that have followed the issuer for a
significant period of time in determining how much
additional due diligence must be performed by the
underwriter in order to satisfy the applicable due
diligence standard.
(d) Underwriters also may consider whether a Disclosure
Committee (see below) was established and may take into
account the scope of the review engaged in by the
Disclosure Committee.
(e) These additional factors may be interpreted as indicia
of "reasonable investigation"/"reasonable care," but
such factors will be illustrative, not exhaustive or
conclusive. The degree to which any of such factors
will serve as indicators will depend upon the
particular facts of the offering (including whether the
offering is a routine financing).
Need to Monitor Developments The Commission should solicit
comment, and monitor developments regarding the due
diligence practices of underwriters during the pilot stage,
to determine if offering techniques developed under the
company registration system adversely affect either investor
protection or an underwriter's ability to perform due
diligence or create an unreasonable risk of liability for
underwriters. The Commission then could consider whether
the proposed new rule could be strengthened consistent with
the protection of investors, premised perhaps on the
underwriter following specified procedures to identify
disclosure problems.
After experience with the company registration system,
consideration could be given to whether the additional
due diligence benefits under these provisions could be
made available to all registered offerings, not just
those made pursuant to the Form C-1. However, such
benefits likely should be conditioned on adoption of
the mandatory enhancements described in Section 4
above, and extension of liability as described above.
Consequently, it is likely that these additional
benefits would be applicable only to the company
registration system.
6. Delegation to Disclosure Committee The Committee
considered, in the course of its deliberations on the
company registration model, a separate proposal to expand
the role of the outside directors in ensuring the integrity
of corporate disclosures. Although not an integral or
necessary part of the company registration model developed
by the Committee, the Committee determined to recommend that
==========================================START OF PAGE 19======
the Commission endorse a new procedure that would allow (but
not require) outside directors to use the issuer's audit
committee or a separate committee of one or more outside
directors (a "Disclosure Committee") to conduct
investigation of the issuer's disclosures. The Committee
believes that this proposal has merit whether or not company
registration is pursued by the Commission.
The Disclosure Committee can perform the investigative
function on behalf of all outside directors, so long as:
(i) the delegating directors reasonably believe that
the member(s) of the Disclosure Committee are
sufficiently knowledgeable and capable of exercising
the due diligence obligations on behalf of the outside
directors (if necessary, with the assistance of their
professional advisers) and with adequate resources,
i.e., the delegation must be reasonable;
(ii) the delegating directors maintain appropriate
oversight of the Disclosure Committee (including by
requiring the Disclosure Committee to report to the
Board on the procedures followed to ensure the
integrity of the disclosure) and reasonably believe
that the Disclosure Committee's procedures are adequate
and are being performed; and
(iii) the delegating directors reasonably believe that
the disclosure is not materially false or misleading.
7. Summary of Benefits of the Proposed Company Registration
System
(a) Benefits to Issuers and Affiliates
Speed of access to market: market considerations,
rather than regulatory concerns, will govern
timing -- elimination of mandatory waiting period
and Commission staff review that now add cost and
uncertainty.
Greater flexibility to go to market more often in
lesser amounts, in light of lower transaction
costs and less delay and uncertainty -- adoption
of "just in time capital" techniques.
Elimination of the potential negative price impact
known as "market overhang," that may still result
from registering equity securities on a universal
shelf for many issuers.
==========================================START OF PAGE 20======
Greater flexibility in determining nature of
marketing efforts -- timing and content of
prospectus driven by informational needs of
investors, not the need to prepare and deliver
after-the-fact compliance documents determined by
regulation.
Elimination of a separate registration requirement
for acquisitions.
Payment of filing fees at time of sale, rather
than in advance (as in the case of shelf
offerings).
Reduction or elimination of concerns regarding
gun-jumping, integration, general solicitation,
restricted securities, and other constructs
developed over the years to maintain the
separation of the public and private markets.
Elimination of discount attaching to sale of
restricted securities in private markets.
Lower risk premiums paid on cost of capital as a
result of enhanced disclosure practices.
(b) Benefits to Investors
Disclosure enhancements will result in better due
diligence practices and raise level and
reliability of corporate reporting, benefitting
purchasers in both primary offerings and in the
secondary market.
Greater flexibility in negotiating transactions
due to elimination of regulatory constraints
(eliminates timing constraints, fungibility
constraints, resale restrictions, etc.).
Protection afforded by registration provisions,
including statutory remedies, potentially extended
to broader class of transactions that otherwise
would be conducted outside those protections, such
as private placements or flowback of securities
from overseas offerings.
Full liquidity for what otherwise would be
privately placed securities.
In contrast to the prospectus supplement procedure
currently used in shelf offerings, transactional
information and material development disclosures
==========================================START OF PAGE 21======
would be covered by Section 11 liability and
provided to the trading markets in a more timely
fashion.
Lower costs of capital raising incurred by issuers
will inure to the benefit of the issuer's
shareholders through greater productivity and
profits.
Improved prospectus disclosure that permits
issuers to prepare offering documents containing
clear and concise information tailored to the
needs of investors and the nature of the
transaction.
==========================================START OF PAGE 22======
(c) Benefits to Underwriters, Officers, and Directors
Elimination of registration requirements and
resale restrictions with respect to most directors
and officers that are imposed as a result of their
status as "affiliates."
Better opportunity to perform adequate due
diligence due to Form 8-K filing requirements.
Significantly better guidance as to what
constitutes a reasonable investigation in the
context of integrated disclosure and streamlined
offering processes.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
CHARTER OF THE SECURITIES AND EXCHANGE COMMISSION
ADVISORY COMMITTEE ON THE CAPITAL FORMATION AND REGULATORY
PROCESSES
Preamble
In accordance with the terms and provisions of the Federal
Advisory Committee Act, as amended, 5 U.S.C. App., Chairman
Arthur Levitt, with the concurrence of the other members of the
Securities and Exchange Commission ("Commission"), hereby
establishes an Advisory Committee to advise the Commission
regarding the informational needs of investors and the regulatory
costs imposed on the U.S. securities markets.
Charter
Pursuant to Section 9(c) of the Federal Advisory Committee
Act, and by direction of the Chairman of the Commission, with the
concurrence of the other members of the Commission:
(A) The Advisory Committee's official designation is the
"Securities and Exchange Commission Advisory Committee on the
Capital Formation and Regulatory Processes."
(B) The Advisory Committee's objective is to assist the
Commission in evaluating the efficiency and effectiveness of the
regulatory process and the disclosure requirements relating to
public offerings of securities, secondary market trading and
corporate reporting, and in identifying and developing means to
minimize costs imposed by current regulatory programs, from the
perspective of investors, issuers, the various market
participants, and other interested persons and regulatory
authorities.
(C) The Advisory Committee shall operate on a continuing
basis until the Chairman of the Commission, with the concurrence
of the other members of the Commission, determines that its
continuance is no longer in the public interest, subject to
paragraph (I) of this charter, set forth below, and Section
14(a)(2) of the Federal Advisory Committee Act.
(D) The Chairman of the Commission, or his designee, shall
receive the advice of the Advisory Committee on behalf of the
Commission.
(E) The Commission shall provide any necessary support
services.
(F) The duties of the Advisory Committee shall be solely
advisory and shall extend only to the submission of advice or
recommendations to the Commission. Determinations of action to
be taken and policy to be expressed with respect to matters upon
==========================================START OF PAGE 2======
which the Advisory Committee provides advice or recommendations
shall be made solely by the Commission.
(G) The estimated annual operating costs in dollars and
staff-years of the Advisory Committee are as follows:
(1) Dollar Cost: $20,000 per year, for the travel, per
diem, and miscellaneous expenses of Advisory
Committee members and Commission personnel.
(2) Staff-Years: 3 staff-years, per year, of
Commission personnel time on a continuing basis.
(H) The Advisory Committee shall meet at such intervals as
are necessary to carry out its functions. It is estimated the
meetings of the full Advisory Committee generally will occur no
more frequently than nine times; meetings of subgroups of the
full Advisory Committee will likely occur more frequently.
(I) The Advisory Committee shall terminate at the end of
one year from the date of its establishment unless, prior to such
time, its charter is renewed in accordance with the Federal
Advisory Committee Act, or unless the Chairman, with the
concurrence of the other members of the Commission, shall direct
that the Advisory Committee terminate on an earlier date.
(J) This charter has been filed with the Chairman of the
Commission, the Senate Committee on Banking, Housing, and Urban
Affairs, the House Committee on Commerce, and furnished to the
Library of Congress on February 24, 1995.
__/s/______________________________
Arthur Levitt
Chairman
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
CHARTER OF THE SECURITIES AND EXCHANGE COMMISSION
ADVISORY COMMITTEE ON THE CAPITAL FORMATION AND REGULATORY
PROCESSES
Preamble
In accordance with the terms and provisions of the Federal
Advisory Committee Act, as amended, 5 U.S.C. App., Chairman
Arthur Levitt, with the concurrence of the other members of the
Securities and Exchange Commission ("Commission"), hereby renews
an Advisory Committee to advise the Commission regarding the
informational needs of investors and the regulatory costs imposed
on the U.S. securities markets.
Charter
Pursuant to Section 9(c) of the Federal Advisory Committee
Act, and by direction of the Chairman of the Commission, with the
concurrence of the other members of the Commission:
(A) The Advisory Committee's official designation is the
"Securities and Exchange Commission Advisory Committee on the
Capital Formation and Regulatory Processes."
(B) The Advisory Committee's objective is to assist the
Commission in evaluating the efficiency and effectiveness of the
regulatory process and the disclosure requirements relating to
public offerings of securities, secondary market trading and
corporate reporting, and in identifying and developing means to
minimize costs imposed by current regulatory programs, from the
perspective of investors, issuers, the various market
participants, and other interested persons and regulatory
authorities.
(C) The Advisory Committee shall operate on a continuing
basis until the Chairman of the Commission, with the concurrence
of the other members of the Commission, determines that its
continuance is no longer in the public interest, subject to
paragraph (I) of this charter, set forth below, and Section
14(a)(2) of the Federal Advisory Committee Act.
(D) The Chairman of the Commission, or his designee, shall
receive the advice of the Advisory Committee on behalf of the
Commission.
(E) The Commission shall provide any necessary support
services.
==========================================START OF PAGE 2======
(F) The duties of the Advisory Committee shall be solely
advisory and shall extend only to the submission of advice or
recommendations to the Commission. Determinations of action to
be taken and policy to be expressed with respect to matters upon
which the Advisory Committee provides advice or recommendations
shall be made solely by the Commission.
(G) The estimated annual operating costs in dollars and
staff-years of the Advisory Committee are as follows:
(1) Dollar Cost: $20,000 per year, for the travel, per
diem, and miscellaneous expenses of Advisory
Committee members and Commission personnel.
(2) Staff-Years: 1 staff-year, per year, of
Commission personnel time on a continuing basis.
(H) The Advisory Committee shall meet at such intervals as
are necessary to carry out its functions. It is estimated the
meetings of the full Advisory Committee generally will occur no
more frequently than 5 times; meetings of subgroups of the full
Advisory Committee will likely occur more frequently.
(I) The Advisory Committee shall terminate on September 30,
1996, unless, prior to such time, its charter is renewed in
accordance with the Federal Advisory Committee Act, or unless the
Chairman, with the concurrence of the other members of the
Commission, shall direct that the Advisory Committee terminate on
an earlier date.
(J) This charter has been filed with the Chairman of the
Commission, the Senate Committee on Banking, Housing, and Urban
Affairs, the House Committee on Commerce, and furnished to the
Library of Congress on February 21, 1996.
__/s/________________________________
Arthur Levitt
Chairman